Debt mutual funds offers excellent investment opportunity to retail investors. You can consider debt mutual funds as part of your debt portfolio.
Advantages of investing in Debt Mutual Funds
Debt Mutual Funds are more tax friendly than bank deposits
If you invest in the debt mutual funds for more than a year, the income from it will be treated as long term capital gain. It will be taxed at 20% with indexation benefits. In indexation, the cost of your investment is adjusted upwards to offset for the inflation.
Let us see it through an example:
If you had invested 1 Lakh in debt mutual funds on 20th March. 2011, it will be 1, 09,000 after 1 year assuming a return of 9%.If you redeem it on 25th March. 2012, you will get the above amount without any TDS. Let us see how tax is calculated on this gain of 9000/-.
Cost of inflation Index for 2010-11: 711, Cost of inflation index for 2011 -12: 785
The indexed cost of investment = 1, 00,000 x 785/711 = 1, 10,408/-. So, after 1 year, when you are redeeming this investment, you have a long term capital loss of 1408/- (110408 – 109000 = 1408) and no need to pay any tax on this 9000/- gain. What is more, you can carry forward this loss of 1408 for the next 8 years to be adjusted against any gain.
If you are an investor in shares/equity mutual funds and incur some short term capital losses in that, such losses can be adjusted against long term capital gains from debt mutual funds. Thus share market losses can reduce your tax burden.
Had you invested this 1 lakh in bank FD, you were liable to pay tax as per your tax slab, that too on annual basis. If you are investing in a 5 year FD, you have to pay tax on the accrued interest every year, though you will get the maturity amount after 5 years. But in debt mutual funds, you pay tax on the gains, only at the time of selling the fund. This way you can postpone your tax liability.
If you invest in debt mutual funds in the name of your minor child and redeem the fund after the child turns 18, you can avoid the tax liability because the income will be treated as that of the child.
Debt mutual funds offers higher liquidity
Debt mutual funds can highly liquid and you can encash it very fast. In most cases, redemption request will be processed within a day. Some debt mutual funds are having small exit loads upto 1 year, depending on the type of funds. You can make partial withdrawals also without breaking the entire investment.
Debt mutual funds are more flexible
Debt mutual funds are more flexible compared to fixed deposits. You can invest in this by way of SIPs and withdraw through SWP (Systematic Withdrawal Plan). SWP is most suitable for retired persons to withdraw money for the monthly expenses. If you have a lump sum to invest in an equity fund, it will be ideal to invest first in debt mutual funds and opt for a systematic transfer plan to the equity fund of your choice. This will help you to average out the cost. As long as the amount is in debt mutual funds, you will get around 8-9% returns compared to the savings bank rate of 4%.
You can invest online to make the transaction easy. You can invest directly through the websites of the Fund houses or can use portals like Funds India (Debt Mutual Funds). You can do most of the transactions online.
Different types of Debt Mutual Funds
- Liquid Funds: These funds invest primarily in call money markets and ensure safety and liquidity. They offer returns comparable to FDs. There is no entry or exit loads in such funds. If you redeem your investment before 3 pm, the amount will be credited to your bank account by 12 noon of the next working day. This fund is ideal for your very short term investments.
- Ultra Short Term Debt mutual funds (Liquid plus Funds): if you need money in 6-12 months, you can consider these funds. They invest in bonds of very short maturities. Any change in interest rate will not affect them. This offers slightly better returns than the liquid funds.
- Long term Debt mutual funds: If you want to invest for more than a year, you can look for long term debt mutual funds. Such funds invest in bonds of long duration. These funds will be more volatile compared to short term debt mutual funds.
- Dynamic Bond funds: These funds invest in corporate bonds and government securities. But they have the flexibility to actively manage the duration of the portfolio, depending on the interest rate situation.
Depending on your duration of your investments, you can select the ideal funds from the right category. Debt mutual funds are much attractive for those in the 30% tax slab, because of the tax benefits it offer.
Before starting next RD or FD, think of “Debt Mutual Funds”.