Introduction
Many investors look for safe and steady investment options that can provide them with regular cash flow. One popular choice is the monthly income plan, often favored by retirees, conservative investors, and families seeking predictable income. While monthly income plans (MIPs) are designed to balance safety and returns, it is important to understand that no investment is entirely risk-free.
Before committing your money, you must carefully evaluate the risks of investing in a monthly income plan—from market fluctuations to liquidity concerns. In this blog, we’ll explore the potential downsides of MIPs in detail so you can make an informed decision about whether they align with your financial goals.
What Is a Monthly Income Plan?
A monthly income plan is a type of hybrid mutual fund that primarily invests in debt instruments (such as bonds, debentures, and government securities) and allocates a smaller portion (15–25%) to equity. This mix helps generate regular returns while minimizing volatility.
Investors usually opt for one of two payout options:
- Dividend Option – where the fund distributes income periodically (monthly, quarterly, or annually).
- Growth Option – where returns are reinvested and can be withdrawn later through a Systematic Withdrawal Plan (SWP).
Though positioned as a steady income generator, MIPs carry certain risks that could impact both income and capital.
Key Risks of Investing in a Monthly Income Plan
1. Market Risk
MIPs are not entirely immune to stock market fluctuations because a portion of their portfolio is invested in equities. If the equity market performs poorly, the overall returns of the plan may decline.
- Example: If the market faces a downturn, the dividend payout may reduce or even stop temporarily.
Impact: Investors expecting stable income may face disappointment during volatile market conditions.
2. Interest Rate Risk
Since a large portion of MIPs is invested in debt instruments, changes in interest rates have a direct impact.
- When interest rates rise, bond prices fall, which can reduce the Net Asset Value (NAV) of the plan.
- Conversely, when interest rates drop, debt instruments deliver better returns.
Impact: Returns are not fixed like a fixed deposit (FD); they can fluctuate depending on the interest rate cycle.
3. Dividend Risk
One of the most common misconceptions about monthly income plans is that they guarantee fixed monthly payouts. In reality, the dividends declared depend on the fund’s performance. If earnings are low, the fund may skip or reduce payouts.
- Example: Even though it’s called a “monthly income plan,” there is no certainty that you will get income every month.
Impact: Investors relying solely on MIPs for expenses may struggle during low-return periods.
4. Credit Risk
MIPs invest in debt instruments issued by companies and governments. If the issuer defaults on payments (interest or principal), the fund’s performance may suffer.
- Example: If a company whose bonds are part of the MIP defaults, the fund NAV may fall.
Impact: While fund managers usually choose high-quality debt, credit risk still exists.
5. Liquidity Risk
Monthly income plans are best suited for medium- to long-term investors. Withdrawing funds too early could lead to exit loads or reduced returns.
- Most funds have an exit load if you redeem units within 1–3 years.
Impact: Investors who may need funds urgently might find MIPs less flexible compared to bank accounts or short-term deposits.
6. Inflation Risk
While MIPs aim to provide regular income, the returns may not always keep pace with inflation.
- For instance, if inflation rises to 7% and your MIP generates 6% returns, your real purchasing power decreases.
Impact: Over time, your monthly income may not be sufficient to cover rising living expenses.
7. Reinvestment Risk
If dividends are distributed, investors may need to reinvest them to grow wealth. However, reinvesting may not always yield the same return as the original investment, especially during low-interest-rate periods.
Impact: This makes long-term financial planning more complex.
8. Taxation Risk
The tax treatment of MIPs may reduce effective returns.
- Dividends are taxed in the hands of investors as per their income tax slab.
- Long-term capital gains (beyond 3 years) are taxed at 20% with indexation, while short-term gains are taxed as per the slab rate.
Impact: For high-income individuals, the tax liability on MIPs can significantly reduce post-tax returns compared to other instruments.
Comparing MIP Risks with Other Investments
| Factor | Monthly Income Plan (MIP) | Fixed Deposit (FD) | Equity Mutual Fund | Bonds / Debt Funds |
|---|---|---|---|---|
| Income Guarantee | Not guaranteed | Guaranteed | Not guaranteed | Depends on issuer |
| Market Exposure | Low to moderate (equity + debt) | None | High | Low to moderate |
| Risk Level | Moderate | Low | High | Moderate |
| Liquidity | Medium (exit loads may apply) | High (premature withdrawal penalty) | High (subject to NAV) | Medium |
| Inflation Protection | Partial | Poor | Strong (long term) | Moderate |
Who Should Be Cautious About MIPs?
While MIPs can be beneficial, certain groups should be extra cautious:
- Dependents on Fixed Income: Retirees who rely entirely on MIPs may face income inconsistency.
- Short-Term Investors: Those looking for short-term parking of funds may be better off with FDs or liquid funds.
- Risk-Averse Investors: People who cannot tolerate even small fluctuations in income may find MIPs stressful.
- High-Tax Bracket Investors: Those in the highest tax bracket might find the post-tax returns less attractive.
Strategies to Reduce Risks in Monthly Income Plans
1. Diversify Your Portfolio
Don’t rely solely on MIPs for income. Combine them with FDs, bonds, and dividend-paying stocks.
2. Opt for Growth + SWP Instead of Dividend Option
The dividend option can be inconsistent. Instead, choose the growth option and set up a Systematic Withdrawal Plan (SWP) to create fixed monthly income.
3. Invest in High-Rated Funds
Select MIPs that primarily invest in high-quality debt instruments and have a good track record.
4. Monitor Inflation
Ensure your overall portfolio (not just MIPs) is inflation-beating by including equity and other growth assets.
5. Plan for Liquidity
Keep some portion of your portfolio in highly liquid assets for emergencies so you don’t need to exit MIPs prematurely.
Real-Life Example: Understanding the Risk
Let’s assume Mr. Sharma, a retiree, invests ₹20 lakhs in a monthly income plan expecting ₹15,000 per month. For the first year, the fund performs well, and he receives regular payouts. However, during a market downturn, the fund reduces dividends, and his monthly payout drops to ₹9,000.
If Mr. Sharma had not diversified his investments and relied solely on the MIP, his lifestyle and financial stability could be impacted. This highlights the importance of risk awareness and diversification.
Are MIPs Worth the Risk?
Despite their risks, MIPs are still attractive for investors who want a balance of income and growth. They are not as safe as fixed deposits, but they offer higher return potential. On the other hand, they are not as volatile as equity mutual funds, making them a middle-ground investment.
If chosen carefully and used as part of a diversified portfolio, MIPs can provide stability and regular income without exposing investors to extreme risk.
Conclusion
A monthly income plan is a smart option for investors seeking regular returns with moderate risk exposure. However, it is crucial to understand the associated risks—market fluctuations, interest rate changes, dividend inconsistency, and inflation impact.
The key takeaway is that MIPs should not be seen as guaranteed salary replacements or fixed-income products. Instead, they should be treated as supplementary income tools within a diversified investment strategy. With proper planning, MIPs can help you achieve financial stability, but only if you are prepared for the inherent risks.