Debt Investment Planning

SIP in Good idea! Debt Funds? 

Mukesh Dedhia, CA, CFP, FRM, LUTCF Director,
Ghalla Bhansali stock brokers Pvt Ltd. 



Setting aside a fixed amount of money every month, specifically for savings or investment, is the best way to create wealth. For people willing to invest a fixed amount every month rather than a single time investment of a lumpsum amount, opening a RD, PPF or starting a SIP are the most preferred options. Fixed deposits have been a part of each and every Indian household. Our grandparents and parents have all invested in FDs at least once in their lifetime. All bonuses went to FDs. Whenever they had to save money for a goal, they put it in an FD. It was the best option to earn interest while ensuring capital protection. 

The declining interest rate regime and the excessive liquidity caused by demonetisation, higher savings and financial literacy have forced banks to reduce their FD interest rates to historic lows. This, in turn, is forcing investors to look for investment alternatives with higher returns, whilst ensuring maximum safety of capital. But is there a more efficient way to earn? We investigate.

Over the past few years, mutual funds are increasingly becoming a part of investor portfolios. A debt fund is a type of mutual fund which invests most of the money gathered from investors into fixed income instruments like corporate bonds, bonds issued by banks, government bonds, certificate of deposit, treasury bills, etc. There are numerous benefits to investors doing SIPs in debt funds instead of traditional instruments like Recurring Deposits. 

Some of the most striking features of SIPs in debt funds are given below.

Safety
Bank deposits are most likely one of the safest avenues for investors with an almost negligible chance of default. As with all mutual funds, there are no guarantees in debt funds either. Returns are marketlinked and the investor is fully exposed to defaults or any other credit problems in the entities whose bonds are being invested in. However, the MF industry is closely regulated and monitored by the regulator, Securities and Exchange Board of India (SEBI). Regulations put in place by SEBI keep tight reins on the risk profile of investments, concentration of risk in funds, valuation of investments and the compliance of funds with their goals. In the past, these measures have proved to be highly effective with very few adverse cases.

Taxation
The other big difference is taxation. The returns from bank fixed deposits are interest income, and as such, have to be added to your normal income (as income from other sources). Since many investors are in the highest tax bracket, this takes away a large chunk of their returns. Banks also deduct TDS on interest income from fixed deposits. When you invest in a debt mutual fund scheme through a SIP and stay invested for holding period of at least three years, the capital gain is taxable with an indexation benefit and the Long Term Capital Gain tax payable is 20%. This is far better than paying tax as per your tax slab, particularly when you are in the highest tax bracket. However, in the case of debt mutual fund schemes, if the holding period is less than three years, the tax levied will be as per you tax slab. This is compensated by about 1-4% higher returns, depending on the type of debt funds one invests in.

Liquidity
On redemption, open-ended debt funds proceeds are typically credited within a period of 2-3 working days. FDs are also available at 1-2 days’ notice, but these usually carry a heavy penalty if they are redeemed before the maturity date. Most banks currently deduct 1% from the original booked rate or 1% from the original card rate applicable for the period for which the FD has been in force, whichever is lower. These may adversely impact your FD’s effective rate of return in case of pre-mature withdrawal during emergencies. Also, there are penalties if you miss out on an investment in a committed Recurring Deposit. Debt mutual funds, other than Fixed Maturity Plans, do not restrict redemption. However, many funds charge exit loads, ranging from 0.25–1% of the redeemed amount, if they are redeemed within a pre-specified period. Such periods can range anywhere from 15 days to 6 months. Ultra short-term and many short-term funds do not charge exit loads and are best suited to park any emergency fund.

Returns
Debt funds have almost always generated 1-4% higher returns than the average Fixed or Recurring Deposit. Debt fund investments take both credit risk (lending to riskier borrowers) and interest rate risk (the risk of bond prices falling when interest rates rise). Hence, such investments are compensated by higher returns. However, since debt funds invest in a diverse range of securities and are very tightly monitored, they probably offer the best risk-adjusted returns.

To summarize, debt mutual funds are not riskier than bank deposits. For the average investor, an SIP in debt fund has more benefits in terms of higher returns, tax efficiency, liquidity and safety compared to Recurring or Fixed Deposits. The key is to find the most efficient type of debt funds for your goals. We advise you to contact your Financial Advisor and enjoy substantial returns, while not taking any significant risks.

Mukesh Dedhia, Director, Ghalla Bhansali stock brokers Pvt Ltd. 

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