Investing in Debt funds.
Market and experts are flooded with do’s and don ts of investing, some praise equities while others are a big fan of debt instruments , and some believe in going risk neutral with safe options like fixed deposits. Are you a risk averse individual who always considers looking for safe investment options, then this article is for you.
Guaranteed Return
Products that go one step further and ensure that the promised return is paid out are in the guaranteed return space. But there are hardly any such products. Public Provident Fund, Employees’ Provident Fund, and Post Office Monthly Income Scheme are some of them. Insurance policies based on traditional plans also offer some guaranteed returns. However, these products are also getting linked to Government Security Rates which are market linked.
Why Debt Mutual Funds Are An Excellent Alternative To Fixed Deposits?
What are Debt Mutual Funds?
Debt Mutual Funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Debt securities have a fixed maturity date & pay a fixed rate of interest. The returns of a debt mutual fund comprise of –
- Interest income
- Capital appreciation / depreciation in the value of the security due to changes in market dynamics
Who Should Consider Investing in Debt Mutual Funds?
If your investment goals are –
- Less than three + years away
- You are fine with a growth rate of with an optimum (8-9%) rate of return
- You are not comfortable with volatility and willing to adjust your growth expectations accordingly.
Why are Debt Mutual Funds considered to be a Better Option?
Reason why Debt mutual funds score of Fixed Deposits of Banks
Safe Investment Options
One of the strong reasons for individual investing in Fixed Deposits is “they are safe,” but even Debt Mutual Funds are considered to be a safe option. The Debt Mutual Funds come with a credit rating, and anything from sovereign to AA is considered to be a safe option. Debt Mutual funds are not rated themselves, but their safety can be deduced from the portfolio they are invested in.
Higher Post Tax Returns
With Fixed deposits, an individual would have a clear picture of the returns once the deposit matures, however with Debt Mutual funds an individual cannot predict the “guaranteed return” and hence they are market linked.
The Tax Impact
The tax liability arises only at the time of sale of mutual fund units. So, if you purchase debt MF units today, you won’t have to pay any tax until such time you sell those units. It does not matter how long you hold those units.
If holding period for debt mutual fund units (at the time of sale) is less than or equal to 3 years, the resulting capital gains shall be treated as short-term capital gains and taxed at the marginal income tax rate (income tax slab).
However, if the holding period is greater than three years, the resulting capital gains shall be treated as long-term capital gains and taxed at 20% after accounting for indexation.
Simple Withdrawal at any time
Some fixed deposits allow individuals to withdraw prematurely, however, partial withdrawal is not an option. However, in the case of a debt fund, after a one-year lock-in period, the investor has the option to redeem the number of units amounting to the required sum and, that too, without a penalty. If the investment duration were less than one year, an exit load of up to 0.50 percent would be levied.
An example
| Type/Period | Three year | One Year | ||||
| FDs | FMPs | Long Term Debt Funds | FDs | FMPs | Long Term Debt Funds | |
| Initial Investment | 1,00,000 INR | 1,00,000 INR | 1,00,000 INR | 1,00,000 INR | 1,00,000 INR | 1,00,000 INR |
| Date Of Investment | 1.4.2013 | 1.4.2013 | 1.4.2013 | 1.4.2014 | 1.4.2014 | 1.4.2014 |
| Returns P.A | 7.50 % | 9 % | 9.50 % | 7 % | 9 % | 9.50% |
| Date Of Redemption | 31.3.2016 | 31.3.2016 | 31.3.2016 | 31.3.2014 | 31.3.2014 | 31.3.2014 |
| 124,718 | 129,503 | 131,293 | 107,000 | 109,000 | 109,500 | |
| Indexed Cost of acquisition | 100000 | 115,122 | 115,122 | 100000 | 100000 | 100000 |
| Gain after Indexation | 24,718 | 14,380 | 16,171 | 7,000 | 9,000 | 9,500 |
| Tax on Gains | 30.30% | 20% | 20% | 30.30% | 30.30% | 30.30% |
| 7,490 | 2,876 | 3,234 | 2,121 | 2,727 | 2,879 | |
| Net Gain | 117,228 | 126,627 | 128,059 | 104,879 | 106,273 | 106,622 |
| Net Return | 5.44% | 8.19% | 8.59% | 4.88% | 6.27% | 6.62% |
Note: Highest tax bracket considered
- CII 2013-14 939
- CII 2015-16 1081
In the present scenario of falling interest rates, debt funds yield better returns as compared to FDs; especially for people in the highest tax bracket. While one-year returns for Debt Funds may not be very attractive, they are still better than returns from FDs. By investing in Debt Funds for more than three years, one can avail indexation benefits thereby earn higher post tax returns.
Why should I pay fees to you when you don’t guarantee me assured returns?
Experts advise that when an individual is planning for the investment, they should not only look for “guaranteed returns” and costs involved but also how “the money spent now” could bear fruits in the longer run. That should be the motive of the investment plan!
With that said, if we compare the guaranteed return option Fixed Deposit and “paying fees” for Debt Mutual Funds we clearly achieve the objective of planning our financial goals.
So, with proper analysis, one could be assured that investing in Debt Mutual Fund could help you in attaining your goals.
We hope we have answered your queries on how investing in debt mutual funds could help you attain your financial goals. If you still have any unanswered questions or need help, feel free to contact us here.
We would be glad to help you with your planning and investment related decisions.
Samiksha Seth
Content Strategist Dilzer Consultants Pvt Ltd.
Sources
http://www.moneycontrol.com/mf/returns.php#result
https://scripbox.com/blog/why-debt-mutual-funds-are-an-excellent-alternative-to-fixed-deposits
http://www.personalfinanceplan.in/mutual-funds/bank-fixed-deposits-vs-debt-mutual-funds/
14 October 2016