Five reasons to invest in debt mutual funds

While debt mutual funds offer several advantages, very few small investors put their money in these
instruments. ET Wealth lists the reasons that make these funds a better investment choice than other
options in the fixed income space.

1) More liquid than FDs

A debt fund is very liquid—you can withdraw your investments at any time and the money is in your bank
account the next day. Unlike a fixed deposit, the fund house does not levy a penalty for exiting too soon.
Some funds have an exit load if the investment is redeemed within 3-6 months. However, most debt
funds don't levy a charge if the investment is redeemed after one month. Besides, you can make partial
withdrawals, without having to break the entire investment. Also, the procedure for breaking a fixed
deposit requires more paperwork than a click of a mouse.

2) They are more tax efficient

In the long term, debt funds are far more tax efficient than fixed deposits. After one year of investment, the
income from a debt fund is treated as a long-term capital gain and is taxed at either 10% or at 20% after
indexation. In indexation, the cost of investment is raised to account for inflation for the period the
investment is held. The longer you hold a debt fund, the bigger is the indexation benefit. There is also no
TDS in debt funds. In fixed deposits, if your interest income exceeds Rs 10,000 a year, the bank will
deduct 10.3% from this income.
If you are not liable to pay tax, you will have to submit either Form 15H or 15G to escape TDS. The other
problem is that the income from fixed deposits is taxed on an annual basis. You may get the money after
the deposit matures 5-6 years later but the income is taxed every year. In debt funds, the tax is deferred
indefinitely till the investor redeems his units. What's more, the gains from a debt fund can be set off
against short-term and long-term capital losses you may have made in other investments.

3) You don't lose even a day's growth


You don't lose even a day's growth when you invest in an open-ended debt fund. If you invest in a fixed
deposit or a closed-ended fixed maturity plan, you get a lump sum amount at the end of the term. Hectic
work schedules and busy lifestyles mean you may take some time to encash the fixed deposit and then
reinvest the proceeds. In some cases it could be even a month or two before the money is redeployed.
That can be a drag on the overall returns. Besides, there is no telling what the prevailing rate of interest is
when the investment matures. In a debt fund, there is no such problem because the investment never
stops growing till you redeem it.

4) Your returns can be higher

The pre-tax returns from debt funds are comparable with those from other debt options such as fixed
deposits and bonds. But if there are changes in interest rates, your debt fund could give higher returns.
Short-term debt funds are not affected too much by rate changes. Generally, their returns are aligned with
the prevailing fixed deposit returns and the investor gains from the accrual of interest on the bonds in the
fund's portfolio. But funds that invest in long-term bonds are more sensitive to changes in interest rates. If
interest rates decline, the value of the bonds in their portfolio shoots up, leading to capital gains for the
investor. While the average short-term debt fund has given 9.5% returns in the past one year, many long term
bond funds have risen by more than 12% during the same period.

5) They offer greater flexibility

Debt funds are also more flexible than fixed deposits. You can invest small amounts every month by way
of an SIP or whenever you have surplus cash. Can you imagine opening a fixed deposit every time you
have an extra Rs 2,000-3,000 in your bank account? Similarly, you can start an SWP to withdraw a
predetermined sum from your investment every month. This is particularly useful for retirees who want a
fixed income every month. You can also change the amount of the SWP whenever you want.
Another key advantage is that you can seamlessly shift the money from a debt fund to an equity fund or
any other scheme from the same fund house. If you have a substantial amount to invest, put it in lump in
a debt fund and then start a systematic transfer plan to the equity scheme you want to buy. Compared to
the 4% your money would have earned in the savings bank account, it has the potential to earn 9-10% in
the debt fund. The icing on the cake is that there is no penalty if the STP stops due to insufficient money
in your debt fund.

Regards,
Sunil.

 

Shall do that, next time.
Thanks.