We have spoken at length in these pages about the benefits of investing in Mutual funds, as well as about the different types of Funds available in the market. Today, let us look a little more in-depth at a specific type of investment within this category, viz. the Debt Mutual Funds. From an investment perspective, these should be attractive to those with a more conservative risk profile. Indeed, compared to equity investments, whether through direct purchase of stocks or through equity mutual funds, putting your funds into debt mutual funds is certainly a low-risk option.
To understand why this is so, let us understand what a debt mutual fund is. Like all other MF’s, it is a collective investment mechanism where the contributions of multiple investors are pooled and invested by the Asset Management Company through a dedicated fund manager. In case of debt MF’s, the investment is made into instruments like government treasury bills, money-market instruments, commercial paper, corporate bonds and certificates of deposit.
The benefits of investing in Debt MF’s are primarily three-fold:
1. Compared to equity funds, debt MFs are much less subject to market risk. The value of the investment is less likely to fluctuate with the stock market, and should return a decent return over time, whereas for equity instruments the return can also depend on timing the market.
2. On the other end of the spectrum from equity is the safety of the Bank Fixed Deposit. While Debt MF’s do carry a slightly higher risk than a Bank FD, it must be remembered that it is more tax efficient. While interest on Bank FD’s is taxed at your marginal rate of tax and on an accrual basis (i.e. you are taxed even if you opt for cumulative interest payout), in case of Debt Mutual Funds, tax only becomes applicable when you realise your gains by redeeming your investment. Further, if you hold the investment for more than 3 years, the tax is at a lower rate as Long-term capital gain with indexation benefit.
3. Again, while Bank FD’s come with lock-in period and penalties for early withdrawal, Debt MF’s are liquid, and can be redeemed at any time, though some schemes have an exit load at a small percentage for withdrawal within a prescribed period. Even close-ended scheme are usually traded on the stock exchange and hence offer liquidity.
In order to invest in Debt MF’s (or any kind of mutual funds) you need to complete a KYC process through a registrar or a broker. Once this is completed, you can easily invest in Mutual Funds either through your broker or even directly online at the websites of these mutual funds (most, though not all, offer this option).
Which Debt MF you choose needs to be carefully assessed.
A balance of the various types may be opted for in order to get optimum returns.
- Gilt funds: These invest only in treasury bills issued by the Government. While the returns are lower than others, Gilt funds are among the safest investments out there and ideal for long-term safety.
- Liquid funds: These invest in treasury bills, commercial paper and interbank call money. All of these are highly short-term investments and designed for parking excess money in the short term. They are often used as a better place to park funds than holding a very high Savings Account balance.
- Short term funds: These invest in corporate bonds for the most part, with a focus on investments with a maturity of lower than 3 years. For investors looking to grow their wealth over 3 years or less and looking for better returns than Bank FD’s, this is a good option.
- Income funds: These invest across the spectrum of investments mentioned above, and are slightly riskier, with a focus on giving a higher return over a longer period of time, viz. greater than 3 years.
- Fixed Maturity Plans: These are MF’s that invest in bonds and bills and hold them to maturity. The returns are predictable and early redemptions are not allowed (though such MF’s are often traded on the stock exchange). For a fixed horizon, these investments can give good returns in a tax-efficient manner.
On the whole, investing in debt Mutual Funds provides a good alternative to Bank Fixed Deposits and should form a part of your investment portfolio at all times.
