Sanjay was busy on the
phone since last five minutes. Sanjana
sat across the table at a neighbourhood coffee day shop where both of them
agreed to meet in the evening. Finally,
when Sanjay disconnected his phone, Sanjana asked him whom he was speaking for
so long?
Sanjay saw the curious eyes
of Sanjana and offering a smile said, “My relationship manager from XYZ
Bank. She was offering me advice on
managing my money.”
“Oh good. So now you are a special customer of your
bank and have a dedicated relationship manager?” quizzed Sanjana.
“Yeah. I became their special customer since I started
maintaining an average balance of Rs. 2,00,000 in my savings bank account and
fixed deposits. And I shall continue to
be, till the time the average balance is maintained.” answered visibly
delighted Sanjay.
“So to have a privilege of
relationship manager, you maintain a balance of Rs. 2,00,000 in your bank
account!! You are happy to forgo the return on your money for this privilege?”
questioned Sanjana.
Sanjay was quick to reply,
“No, who says I am not earning return.
My savings account gives me 4% and bulk of the money is in fixed deposits,
which earns me anywhere between 7% to 10% per annum. You see my money has been effectively employed
for providing returns plus special customer benefits.”
“The returns you are
mentioning are absolute returns. Have
you ever thought about post tax returns?
If I am not wrong you are in 20% tax rate bracket, right?” to which
Sanjay nodded. Sanjana continued, “Even
if I consider the fixed deposit giving you 10% per annum return, 20% tax would
leave you with post tax return of 8%!!”
A visibly annoyed Sanjay
said, “Well that’s the best return I can get for liquidity and low risk. You only told me other day that one needs to
compromise the return if he is not willing to take risk and wants liquidity.”
“That’s true” said Sanjana pleased
by the fact that Sanjay still remembers what she had told him few months back
when they had discussion on the risk and return trade off. “Savings accounts / fixed
deposits are the best place for high liquidity and minimal risk returns. However, why to maintain a huge balance in
your savings account when there are other low risk, high liquidity alternatives
available providing better returns?”
Confused Sanjay said, “I do
not understand what you are saying. Can
you please elaborate?”
“Sure” Sanjana replied,
“See, I am not against maintaining adequate money in savings / fixed
deposits. This is required for any
unforeseen immediate requirements.
However, one can pep up the returns by investing excess portion of the
money lying in savings account in debt funds which provides liquidity along
with low risk and high returns.”
Suspecting no response from
Sanjay, Sanjana continued. “I am referring to ultra short term debt funds offered
by mutual fund companies. These funds
provide tax-efficient returns with liquidity and low risk. I agree that these funds are not as safe as
fixed deposits, but given the low maturity profile of these funds the risk of
losing money is minimal.”
“Tell me more about them
and especially tax-efficient returns that you mentioned” stated Sanjay eager to
learn from her friend.
“These funds, earlier known as liquid plus funds, invest in
short term debt papers which have maturity of more than 90 days but less than 1
year. Barring few, they do not have any
entry or exit loads and one can redeem it any time with proceeds credited to
bank account by next day or at the max, day after depending on the timing of
your redemption.”
“Since these funds invest
in debt instruments and commercial papers of corporates, their returns are
attractive even after deducting fund management expenses. In last 12 months, good ultra short term
funds managed to provide returns anywhere in excess of 10% to 9%. However, the most important factor which tilts
the pendulum in their favour is their tax treatment.
“Though any gains arising
out of such investments are treated as capital gains and taxed at applicable
short term or long term capital gains rate, many of these funds provides
dividend option and facility to reinvest dividends. The interesting thing is dividends are taxed
at lower rates and thus it boosts post tax returns.
“Let me give you an
example. If you invest in such funds
with daily dividend reinvestment option, any increase in NAV during the day is
declared as dividend by the fund and gets reinvested after paying dividend
distribution tax at 12.5% plus surcharge and education cess. Since dividend is tax free, it is not taxed in
the hands of investor. Since all the
gain is declared as dividend, NAV of the funds remains unchanged and there are
no / insignificant capital gains tax at the time of redemption of units.”
Trying to put things
together, Sanjay said, “So you mean to say there is only dividend income on which fund pays the tax @ 12.5% and dividend is tax free for me. Since this tax rate is less than the tax @
20% which I pay on interest income from fixed deposits, even if the fund earns
10%, my post tax returns are better than post tax returns on fixed deposits. And if one falls in highest tax slab of 30%,
it is more beneficial, right?”
“Absolutely,” said a happy
Sanjana realizing how easy it is to explain to Sanjay, "Tax benefit varies according to one's tax slab. For persons paying 30% tax, the benefit is the highest."
“But if they are tax
efficient, why just ultra short term debt funds which invests in debt papers
with maturity of more than 90 days. I
can also invest in funds which invest in debt papers with maturity of less than
90 days. I am sure there must be such
funds in the market.” It was now Sanjay’s turn to question Sanjana.
“Correct. There are funds which invest in debt papers
with maturity of less than 90 days – those are call liquid funds. However, they are not tax efficient, since dividend
distribution tax on dividend distributed is 25% plus surcharge and
education cess. Thus on post tax return
basis, they are at disadvantage as against ultra short term debt funds.”, Sanjana clarified.
“Okay. I understood.
Ultra short term debt funds provide high post tax returns if one opts
for dividend reinvestment option and they are liquid investments, but slightly
riskier than bank fixed deposits. However one can pep up their returns by investing surplus funds in them.”
“Bingo.” Sanjana nodded, as Sanjay’s mobile rang
again.
Disconnecting the
call, Sanjay smiled and said, ‘Who now needs a
relationship manager if one has such a good friend providing free financial
advice!!’ sipping his cappuccino crowned with choclate sauce.
Have you ever
invested in Ultra Short Term Debt funds?
Share your views on them with us.
