Choose Solution Oriented Fund as per Your Financial Goals

Published On: 24-Jun-2020

Solution oriented mutual funds are such funds that aim to fulfil the specific financial goals of the investors, like retirement, child’s education, marriage, etc. To encourage the investors to invest for the long term, such funds tend to carry a lock-in period of 5 years or till the attainment of the age of retirement/ child’s majority, whichever is earlier. 

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Solution-oriented funds are preferable those investors who are looking to link their investments with specific goals. As on 31st May 2020, around 5.97% of the total investor folios across the mutual fund industry have invested in solution-oriented schemes with AUM (Assets Under Management) of Rs. 0.17 lakh crores (Source: Association of Mutual Funds in India - AMFI).

Different asset classes carry different risk-reward trade-offs for investors. While equity markets may be volatile over the short term, their utility for long term wealth creation does not need much promotion. Similarly, debt investments may be linked with stability and low volatility; the returns generated for the investors may also be more economical. As such, it becomes crucial for investors to align their investment horizon with their financial plan. Solution oriented schemes aim to bridge the gap for such investment needs.

Types of Solution Oriented Schemes

As per the SEBI Guidelines, following two types of solution oriented mutual funds, may be offered by the mutual funds:

  1. Retirement Fund – These are retirement oriented mutual fund schemes having a lock-in period till the age of retirement, subject to a minimum lock-in period of 5 years. 

  2. Children’s Fund – These funds aim for investment for children having a lock-in period till the child attains majority, subject to a minimum lock-in period of 5 years.

Choosing the Investment Option for Solution Oriented Mutual Funds

As the case with other mutual fund schemes, solution-oriented funds are offered under the growth and dividend options. While the returns realised by the dividend option may get distributed to the investors, the returns are reinvested in growth options, thus contributing to the compounding effect on the fund portfolio. The investors should ideally choose growth option, instead of a dividend option to mitigate the reinvestment risk. 

Benefits of Lock-in Period in Solution Oriented Schemes

The lock-in period tends to extend up to 5 years or till the attainment of majority age by the child/ retirement age, whichever is earlier. It brings along several benefits for the investors:

1. Mitigating the Risk of Early Redemptions :

 The mandatory lock-in period also helps the investors to resist the temptation to redeem their mutual fund investments at an early stage, instead of waiting for the investments to achieve the desired value. 

2. Predictability of Fund Outflows :

It also becomes more comfortable for the fund manager to predict the cash outflows for the scheme and accordingly plan for the investment horizon. With the visible trajectory of fund flows required, the fund managers may take long term calls with convenience without worrying for short-term market hiccups.

Tax Incidence of Solution Oriented Schemes

Considering that the solution-oriented schemes are aimed at achieving long term financial goals, the predominant portion of the fund portfolio may be invested in equity securities. Such portfolio orientation helps the investors to generate better returns and benefit from the benefit of compounding over the long term. Thus, such schemes would generally be categorised as equity-oriented funds for tax purposes. (In the Indian context, as per current SEBI Mutual Fund Regulations, an equity mutual fund scheme must invest at least 65% of the scheme’s assets in equities and equity related instruments.)

In case the investor has invested in the dividend option, the dividend income is taxable for the investor at the regular tax rates as applicable to the investor. Further, TDS at the rate of 7.50% (reduced rate by the Govt. because of Covid-19 measures till 31st March 2021) is also deducted by mutual funds on such dividend income if the total dividend paid to an investor exceeds Rs 5,000 in a year.

On the other hand, the appreciation in the NAV (Net Asset Value) of mutual fund units is taxable at the time of redemption of such units as ‘Income from Capital Gains’. The gains may be calculated by deducting the actual investment cost from the redemption proceeds of such units. Such gains funds are categorised as Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG) based on the holding period of mutual fund units. 

If the investor has held the units for less than 12 months, the returns are taxed as STCG at 15% (plus applicable Cess and surcharge). In the case of holding period of 12 months or more, the gains are classified as LTCG and taxed at 10% (plus applicable Cess and surcharge) without any indexation benefit. Further, the investors are also eligible for an exemption of up to Rs. 1 lakh per year in respect of aggregate LTCG from equity shares and equity oriented mutual funds taken together. 

Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Union Budget 2020 passed by the Parliament and the Covid-19 related measures announced by the Govt. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.