How debt funds can work for you
funds held for three years or more are taxed at 20% with indexation. As investment grows naturally by rate of inflation, only gain over and above inflation growth is taxed. Term deposits and savings accounts are taxed at marginal tax rate, irrespective of holding period.
There are different types of debt mutual funds that can cater to the various requirements of investors. The different funds have different degrees of risk associated with them and it is important to pick the right fund for your investment needs. Fixed income investments have two primary risks: interest rate risk and credit risk.
Money invested in a corporate or lent to an individual earns a certain interest rate. If the market interest rate increases, the lender or investor is at a loss receiving lower interest and hence, the investment value goes down. When market interest rates go down because investment yields higher interest the value goes up. Credit risk is the risk of the company or individual not being able to pay back the money.
Liquid funds are very low on both of the above risks, and investors who need a relatively safe and liquid investment may consider it instead of keeping large sums locked up in their savings accounts. Liquid funds usually yield a higher interest than savings accounts. There are other mutual funds that have varying degrees of maturity (higher maturity means higher interest rate risk) and invest in different entities (with high or low credit risk).
Another important use for fixed income funds is diversification. Equity is the sword which attacks inflation while fixed income can be the shield which defends against volatility. Financial planning generally recommends that any individual near the age of 30 should include at least 20% debt investments in their portfolio depending on their risk appetite.
When you invest in a debt fund, there are many underlying bonds and other securities. Through the vehicle of debt fund, you get access to commercial paper, government bonds, public sector bonds and corporate bonds across rating profiles. It also gives you flexibility.
*Assets are average assets for the month of September 2018, as per AMFI
Kalpen Parekh is the President at DSP Investment Managers Pvt Ltd