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Growing Your Wealth With Debt MFs

| 10/18/2012 9:00 PM Thursday

I am a 50-year old professional and plan to work for five years more. I am well settled, with no further liabilities/commitments. I would like to invest in another property after three years, which will be worth around Rs 1 crore. Currently, I have saved about Rs 80 lakh in FDs as I prefer not to invest in risky assets like equities or MFs. I am in the highest tax bracket. I would like guidance on safe investment avenues to reach my target.

- Raviraj Jaykar

Your decision to eschew equities is wise, as a two-year horizon is not sufficient to benefit from equity investments. However, you may want to consider diversifying your investment avenues to generate higher returns. While investments in FDs are perceived to be relatively safer than those in many other asset classes, they are unlikely to generate the returns you need. You could invest in debt mutual funds (MFs) for higher returns.

MFs are designed to protect investors. A mutual fund is set up as a trust, and the investors are the beneficiaries. The assets of the MF company are held by a custodian. Therefore, an MF default will not affect your investment in the fund. Investments in FDs are protected against default to some extent. In case of a bank failure, the government’s deposit insurance scheme will cover up to Rs 1 lakh of your deposit and there is no guarantee with respect to the remainder.

The RBI’s decision to slash the CRR by 25 basis points has led to a fall in deposit rates. Currently, three-year FD rates are around eight per cent. When you invest in a three-year FD, you will only receive the money after three years but will still be taxed each year. Your return after tax will only be 5.6 per cent (eight per cent less tax of 30 per cent).

As shown in the table, your investment of Rs 80 lakh will only grow to Rs 94.2 lakh at the end of three years. This will lead to a shortfall of almost Rs 6 lakh. You may need to supplement your investment with a loan or other funds to purchase the property. In addition, investments in FDs are liable to TDS (Tax Deducted At Source), which will further erode your investment.

YearValue Of Investment (Rs/Lakh)
1 80.0 + 5.6% = 84.5
2 84.5 + 5.6% = 89.2
3 89.2 + 5.6% = 94.2
Shortfall: Rs. 5.8 lakh

Debt MFs will help your investment grow faster. You could invest the Rs 80 lakh in short-term and medium-term debt funds with maturities between one-two years. These funds are less volatile than equities or long-duration funds. Currently, the yields (pre-tax) of short-term funds are about 9.5 per cent, while those of medium-term funds are about 10-10.5 per cent. Year-to-date, some short and medium-term funds have generated double-digit returns.

These funds usually invest in a variety of debt instruments including commercial paper, certificate of deposits (similar to FD), corporate bonds and government securities, which will diversify your portfolio. These fund portfolios are rated by credit agencies such as CRISIL and ICRA. Several short and medium-term debt funds generally have portfolios rated AA and above. According to CRISIL, a rating of AA indicates ‘a high degree of safety’.

 

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