Loss in liquid fund – Sad but true

I was not only surprised but also shocked to know that one of our clients has made loss of 4.4% in just 21/2 month in one of liquid fund. He has invested Rs. 3 lakhs on 10^th January’2013 in one of liquid fund – Treasury Plan. He has invested smartly in direct plans in which charges are lower than regular plans. He received his statement dated 26^th March’2013 mentioning his current fund value at Rs. 2,86,791. The net loss is approx. 13,200 i.e. around 4.4% absolute and unbelievable 21% annualised. This is the real fact and there is no error as we checked the respective NAVs at AMCs website. While assessing the real fact we were surprised to know the answer that why this happened and the result was an eye opener for us. This happened only because our client has opted for dividend reinvestment option. The result would have been the same in dividend payout option also. The AMC recently declared a huge dividend in the plan, may be due to year end, which eroded our clients investment. Most of the lay investors do not know that there is dividend distribution tax of 27.0375% in liquid funds which is deducted from dividend amount while giving final effect. This DDT resulted in net loss to our client.

Most of the lay investors opt for dividend option as the dividend in their hand is tax free but fail to understand the impact of other taxes like DDT. Normally dividend is expected from the growth amount but in his case dividend is paid from the principal amount invested which did not appreciated much in last two months. Liquid funds are believed to be the safest investment as your principal does not depreciate. Yes, there is no negative return and loss only occurred because of DDT in his case. But loss is a loss and the other facts cannot be ignored even if you are investing in safe instruments. If he has opted for the growth option, needless to say, there is positive return in the growth option. The name is not mentioned only because I believe that this can happen in any fund if you choose your sub option without knowing its implication. Not only selecting right asset class is important but it is equally important to opt for right sub option. If you make a mistake in selecting sub option then it can result in financial loss even if you have chosen the right asset class.

There are four sub options normally available in the mutual fund scheme, Growth, Dividend Payout, Dividend Reinvestment and Bonus. According to me dividend option in debt fund does not make any sense due to high dividend distribution tax. As per current budget DDT shall be 28.325% in all debt and liquid funds w.e.f. 1^st June’2013 which one must know while opting for the sub option in mutual fund investment. So if you opt for dividend option in debt or liquid funds whether pay out or reinvestment option you already are taxed at higher rate whether you fall in that tax slab or not. The above real life example speaks for itself.

Secondly one has to be also careful while opting for systematic transfer plan by depositing lump sum in liquid plans. Most of the distributors give the similar advice for lump sum investment, park lump sum fund in liquid fund with sub option of daily dividend payout option and transfer investment periodically mostly monthly in equity scheme by systematic transfer plan. This can give again negative return on lump sum investment as given in above example. It is advisable to invest through systematic investment plan by keeping money in savings bank account. If you have a large sum for investment, you have the option of opening bank account with Yes bank or Kotak bank which pays higher rate of interest on savings bank account. 

  

It is always advisable to take the professional advice before making a large lump sum investment specifically if you want regular income out of investment. It is also important to know and understand the tax implications and risk involved in the plan. If you have invested in dividend option in any of debt fund, I think you must review your investment at earliest. 

Article is first published at myiris.com on 17th April'2013. below is the link.

http://www.myiris.com/financial/storyShow.php?dir=2013/04/17/&fileR=20130417094155715