Debt mutual funds are funds
that invest in fixed-income instruments such as corporate and PSU companies’
bonds, government bonds, commercial paper and so on. Investors put their money
in debt funds as a hedge against volatility in the capital markets. While
equity investments can shoot up or plunge quite rapidly, debt funds are a stable refuge to
build a strong moat one can rely on in choppy markets.
Let’s take a look at the major advantages of having debt funds in your portfolio:
1. Extremely liquid investment
Investment
in a debt mutual fund is considered more liquid than even
fixed deposits. While you can cash in on your debt fund investment on a day’s
notice, breaking your FD could take more time since it generally involves some
paperwork rather than just a tap on your phone screen or the click of a mouse.
Moreover, you can liquidate a debt mutual fund SIP without attracting any
charges from a fund house whereas a bank will levy a penalty for withdrawing
your FD money before maturity.
Now
mutual funds also provide an instant liquidity option under the instant redemption
facility in liquid funds for withdrawals up to Rs 50,000
Additional Read: What are the benefits of
investing in Liquid Funds?
2. Tax benefits are better
Investing
in a debt mutual fund is more beneficial on the tax front in the long run than
an equity investment or a fixed deposit. Returns from an equity scheme will
attract a short term capital gains tax of 15% if the investment is sold before
a year and long term capital gain tax of 10% for investments sold after a year.
If debt mutual fund investments are sold before three years
then the returns are added to the total income and taxed as per the applicable
income tax slab.
Capital
gains are taxed at the marginal tax rate i.e. the gains are added to the total
income and taxed as per the applicable income tax slab. While holdings greater
than 3 years will be able to reap the benefit of indexation which is not
available in equity. In Indexation your capital gains are adjusted with respect
to inflation and then taxed. As such the longer you hold your debt mutual fund investment, the greater will be the benefit from indexation.
If your
FD returns amount to more than Rs 10,000 then the bank will deduct TDS.
Moreover, returns from an FD are taxed every year whereas that from a debt fund
is taxed only on withdrawal.
3. Better returns compared to peers
Investment
in debt funds could earn you higher return on capital than other debt options like
bonds and fixed deposits. While bond yields and FDs are dependent on interest
rates set by the central bank, debt
funds put your money in a motley combination of
debt instruments such as commercial papers, corporate and PSU bonds etc. that may
not suffer a first order impact of frequent rate changes.
Another
important merit to consider is that debt funds can work to your advantage in
both interest rate scenarios — when it’s rising and when it’s falling. This can be achieved by selecting the funds
that benefit in these scenarios. For example, dynamic/ duration funds can
benefit from falling interest rates while accrual funds can be better in a
rising interest scenario.
4. Flexibility
If you
invest in a debt fund SIP, you could devise an SWP (systematic withdrawal plan) to regularly take
out an amount from the investment. This SWP option is also more tax efficient
for investors who need regular income and are in higher tax brackets instead of
dividend options.
There’s
also the flexibility to shift your money to a different scheme in the same fund
house if you think the markets are going in a particular direction and are
expected to stay the course for the time being. This can be done to invest in
equity funds systematically from liquid/debt funds.
5. Money never sleeps
If you invest in a fixed deposit account
or bonds, the money either tends to get used after the term of the investment
or it stays idle until you decide where to invest it. The advantage in an open
ended debt mutual fund investment is that the money will never
be idle and grow each day.
Additional Read: Advantages of Having Debt Mutual
Funds in Your Portfolio
Planning your debt fund investment
Whether you have a low or
high appetite for risk, debt funds serve an important role to balance a
portfolio. It ensures that the low risk investor has money parked in an avenue
where it is growing in a stable manner and can be redirected at short notice if
the markets are on an upward swing. Moreover, if you have a low risk appetite
then you can also use it as an easy fallback option. For an investor with a high risk appetite, a
debt fund can be used to absorb shocks from volatile equity market conditions.
It is a good idea to
periodically switch funds from growth investments like equity to lower risk
debt mutual funds. This lends some much needed balance to the portfolio as
financial goals appear on the horizon. The investor stands to benefit on both
ends when using it as a periodic exit or investment strategy. While the risk of
cashing in on investments from an equity MF when its value is low is avoided,
the periodic strategy tends to minimize the blow from a high entry point to a
large extent.
Conclusion
Debt funds are considerably
low-risk mutual funds and can be opted for by risk averse investors as well as
aggressive investors. While the conservative and a balanced investor should
have it in their portfolio, growth and high growth investors should keep it to
absorb the shocks of the equity market. Whether you want to plan for your
retirement or invest to achieve a financial goal such as a house or a trip
abroad, Tata Capital Wealth Management Solutions can help you achieve it with the right mix of debt fund investments,
equity investments and other categories based on your needs and priorities.
16 October 2020
6 mins read
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