Equity Savings Fund Or Regular Savings Fund, Which Is A Better Option For You? (2024)

The Indian mutual fund industry usually borrows ideas from the West, and the concept of a ‘Savings Fund’ is one of them.

By definition, a Savings Fund is a mutual fund solution for investors seeking a steady level of income, while preserving the capital of their initial investment.

To achieve this objective, Savings Funds invest about 80%-85% of their assets in low-risk investments. The balance 15%-20% of the assets is invested in equity to provide growth.

If you have a low tolerance for risk or have a short investment time horizon of 3-5 years, opt for such funds.

However, if you are seeking long-term growth, Savings Funds are not for you. It would be best to choose an equity mutual fund for your long-term investments.

Until a few years ago, Monthly Income Plans or MIPs were a popular version of Savings Funds. The objective of MIPs is to generate regular income and outperform pure debt investments through a marginal equity exposure.

MIPs generally invest 0% to 30% of their assets in equities and the balance in debt and money market instruments. While investments in debt instruments provide the safety and stability of regular income from coupon payments, the equity investments have the potential to generate extra income through dividends along with capital appreciation over a period of time.

However, post FY 2014-15, their popularity declined as the Government stripped the tax benefits enjoyed by non-equity schemes. The 12-month holding period for classification as Short-term Capital Gains (STCG) was increased to 36 months. STCG is added to the income and taxed accordingly.

For tax on Long-term Capital Gains (LTCG), the option of 10% tax without indexation was withdrawn. The 20% tax with indexation on LTCG continued.

This tax implication led to the rise of Equity Savings Fund. We will come to this category of funds a bit later, but first, let us understand a little more about the change in nomenclature of MIPs.

MIPs now known as a Conservative Hybrid or Hybrid Debt or Regular Savings Fund

Like Balanced Funds, which didn’t actually adopt a balanced exposure to equity and debt, MIPs did not guarantee monthly income. Hence, the name was a misnomer and SEBI sought to address this issue.

With the circular on the categorisation of mutual fund schemes, SEBI classified MIPs as Conservative Hybrid Funds. Under these funds, the investment in equity will be between 10%-25% of total assets and for debt instruments will be between 75% -90% of total assets.

Though these schemes fell into the Conservative Hybrid Fund category, fund houses were given the flexibility in naming their schemes. Hence, erstwhile MIPs now have Conservative Hybrid, Regular Savings, Hybrid Debt or Debt Hybrid in their scheme names.

Do note, some MIPs have been merged or categorised differently. Have a look at the table below for details of scheme name changes, category changes and mergers.

Merged

To know more about other categories and scheme change read our article- Your Mutual Fund Scheme Renamed. What Should You Do?This article will be constantly updated as and when new scheme name changes or classification are announced.

The dawn of Equity Savings Funds

As we mentioned earlier, in the Union Budget 2014-15, the newly elected BJP Government extended the holding period for non-equity mutual fund investments to qualify as long-term capital gains to three years from one year. Along with this, the tax rate of 10% without indexation was withdrawn. Thus, the LTCG tax remained 20% with indexation.

Post-implementation, Fixed Maturity Plans (FMPs) of debt mutual funds went out of flavour. As didMonthly Income Plans (MIPs)and otherhybrid debt-oriented schemes.

To retain investors, fund houses began promoting equity-oriented schemes such asArbitrage Fundsand Equity Savings Funds as a low-risk investment option, which enjoyed a tax-free status after a holding period of one year.

However, the tax-free status is no longer available. The same government chose to tax LTCG arising out of redemption of equity funds from FY2018-19. Gains in excess of Rs 1 lakh will be taxed at 10%.

Equity Savings Funds take a hedged equity exposure (with arbitrage opportunities) up to a maximum of 60%-75% of their portfolio. The unhedged equity exposure is around 15%-25% and the balance is held in debt instruments. Being equity-oriented, with a net equity exposure in excess of 65% towards equity, these funds enjoy the same tax benefits like any other equity scheme.

Equity Savings Fund Vs Regular Savings Fund (erstwhile MIPs): The Showdown

Before we get in to the differences between the two types of fund options, let's understand and summarise their similarities.

The Similarities

Unhedged Equity Exposure: Both types of funds maintain a net long equity exposure of 10%-25%. While SEBI has not specifically spelt out the unhedged equity exposure to be maintained for Equity Savings Funds, most schemes maintained a low exposure to the unhedged equity positions. This marginal exposure gives you the benefit of the wealth-creation potential of equity.

Risk: Both Regular Savings Funds and Equity Savings Funds are riskier than pure debt funds because of their equity component. While both offer the opportunity to earn higher returns than those from pure debt funds, the return may be lower if the equity component performs poorly.

For Equity Savings Funds, the arbitrage portfolio is low-risk, despite investing in derivatives, because fund managers of these schemes do not place speculative bets. If there are no arbitrage opportunities available, the scheme has the flexibility to invest in debt. However, if the overall equity exposure falls below 65%, the scheme could lose its equity status.

Stability through debt or arbitrage opportunities: Regular Savings Funds are free to invest up to 90% of their portfolio in debt instruments across maturities. Most schemes maintain an average maturity of three years or lower. Hence, the volatility is low and returns are stable at around 6%-8%. For Equity Savings Funds, arbitrage opportunities are completely hedged, hence the risk is low. Such positions the usually earn the scheme a return around 6%-7%.

Ideal for conservative investors or short-term investments: If you are a conservative investor with bulk of your investments in fixed income, you could consider such Hybrid Funds with a marginal exposure to equity. Equity investments are more volatile, but they have the ability to generate inflation-beating returns through dividends and capital appreciation. If you have an investment horizon of three years or more, consider investing in these schemes.

The Differences

Taxation

As Equity Savings Funds are equity schemes, and Regular Savings Funds fall under non-equity schemes, they attract different tax norms. The tax implication in itself is a key differentiator between both the schemes.

STCG Tax: If redeemed within a holding period of one year, Equity Savings Funds will attract a STCG tax of just 15%. On the other hand, the gains from Regular Savings Funds are clubbed with your income and taxed as per the tax slabs. Thus, if you fall in the highest tax bracket, the tax on gains could go as high as 30% (35.88% including surcharge and cess). The Conservative Hybrid Funds or Hybrid Debt Funds will be beneficial for investments under one year, only if you fall in the lowest tax bracket of 10%.

LTCG Tax: Equity Savings Funds will attract a LTCG tax of just 10% for gains in excess of Rs 1 lakh. In this case, the minimum holding period to qualify as LTCG is one year. For the non-equity counterparts, the LTCG tax of 20% with indexation applies.

However, you need to hold the units for a minimum of three years. Any redemption prior to three years is added to your income and taxed accordingly. While the net tax on indexed gains may work out lower than a tax of 10% without indexation, you will need to hold the units for a minimum of three years. Equity Savings Funds will work out advantageous if your total gains is under Rs 1 lakh.

Tax on dividends: In both cases, the dividends are tax-free in the hands of the investor. But, the fund house will deduct a tax before paying out the dividend to the investor. For Equity Savings Funds, the fund house will deduct a 10% tax (11.648% including surcharge and cess) on the dividends paid out. In the case of Regular Savings Funds, dividends attract a Dividend Distribution Tax of 25% (29.12% icluding surcharge and cess).

From the analysis above, it is clear that Equity Savings Funds have a clear tax advantage over Regular Saving Funds, specifically for high value investors.

Performance

Most of the Equity Savings Fund were launched in the 2014-15 period or later. Hence, the long term performance of such funds cannot be analysed.

Regular Savings Funds have a longer track record of performance. Hence, you can easily shortlist a scheme that has performed across different market periods and market cycles and those that have demonstrated a superior risk-adjusted performance.

Here, it is also pertinent to note whether the schemes have altered their asset allocation post SEBI's diktat. If so, then the past performance should not be considered.

Unfortunately, we cannot compare Equity Savings Funds in a similar manner as these schemes do not have a long term performance track record. Because they enjoy the tax benefits of an equity scheme, their returns should be better compared to the post-tax returns of Regular Savings Funds.

Nonetheless, if you look at the point-to-point returns using the data that is available, the performance of both categories of funds is almost similar, as seen in the tables above. Certain individual schemes have performed better than the others in specific periods. Given the similarity in risk and returns, the final outcome is dependent on the tax implications.

Costs

The expense ratio for both scheme categories is almost the same. However, the expenses could vary. Being equity oriented, the expense ratio of Equity Savings Funds can go up to 3%. For Debt Hybrid Funds, which are non-equity schemes, the expense ratio can go up to a maximum of 2.75%.

The Final Verdict

As mentioned before, investing in such schemes is unsuitable for short-term investments or investments where protecting your capital is a priority.

When launched, the MIPs were targeted toward retirees who depend on the monthly income from their investments. Such funds were wrongly promoted as an alternative to fixed deposits, without adequate disclosures about the risk involved.

It is important to note, that under Regular Savings Funds and Equity Savings Funds, the returns are not fixed like interest bearing products such as bank fixed deposits or Public Provident Fund or other Smalls Savings Schemes. Neither of the products can guarantee a steady stream of income. Simply because neither debt nor equity can guarantee a fixed return, especially over one to three years.

A short-term correction in the market can lead to a loss of capital. This is a dreadful thought for any investor, especially those dependent on their investments for income. Such investors should best avoid these schemes.

However, for those who are ready to take on the risk, of the two product categories, Equity Savings Funds clearly have a tax advantage. However, their performance depends on the fund managers' ability to make the best out of arbitrage opportunities available. Hence, the skill and experience of the fund manager is a key deciding factor.

Additionally, if you are investing for the long term, say around five years or more, the Regular Savings Funds with the benefit of indexation may turn out to be an apt choice.

Therefore, you need to decide between the two based on your investment goals, time horizon and tax liabilities.

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