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Debt Funds Suitable For Short-Term Investment

| 5/16/2013 9:00 PM Thursday

T Srikanth Bhagavat
Managing Director, Hexagon Capital Advisors
www.hexagononline.com

I am willing to invest an amount of Rs 6 lakh in mutual funds with an aim of buying a car worth Rs 10 lakh in a two-year duration. Should I invest in debt funds or equity funds? 
- Pranay Kolkar

To achieve your goal, the absolute growth on your investment needs to be about 67 per cent over the next two years. You should avoid investing in equity funds, as your investment horizon is quite short. Equity funds have the potential of generating high long-run returns but are subject to short-term volatility. As you have a time horizon of two years, you should invest in debt funds. These funds are relatively safer and more stable than equity funds.

You should invest in a mix of short-term and medium-term debt funds. These funds usually invest in a variety of debt instruments including commercial papers, certificates of deposits, corporate bonds, and government securities. Several short and medium-term debt funds generally have portfolios rated ‘AA’ and above. According to CRISIL, an ‘AA’ rating indicates ‘a high degree of safety’. The short and medium-term funds shown in the table below are some of the top-performers in their categories.

Scheme Performance as on April 22, 2013
Scheme Name Annualised Returns (in months) CAGR (in months)
1 3 6 9 1 2
Birla SL Dynamic Bond Fund(G) 17.45 10.68 10.08 10.89 10.74 10.5
IDFC Dynamic Bond Fund(G) 19.34 12.03 14.21 14.1 13.51 12.73
IDFC SSIF-MT(G) 14.22 9.6 9.36 10.16 10.22 10.23
Templeton India Income Opp(G) 17.53 10.54 10.07 10.95 10.76 10.18
Templeton India ST Income Plan(G) 16.3 10.76 9.96 10.71 10.59 10.07

Over the last two years, these funds have generated returns between 10 per cent and 13 per cent. Although these funds may generate higher returns if interest rates fall, they are unlikely to generate returns of 67 per cent over the next two years.

A portfolio of short and medium-term funds should generate a post-tax yield of about 9 per cent. At this rate, your investment of Rs 6 lakh will grow to about Rs 7.13 lakh after two years (post-tax, assuming long-term capital gains are taxed at 10.3 per cent without indexation). You will have a shortfall of about Rs 2.87 lakh. 

You should increase your investment by about Rs 2.5 lakh to achieve your goal. An investment of Rs 8.5 lakh today should grow to about Rs 10 lakh in two years. Alternatively, if you do not want to invest Rs 8.5 lakh today, you could invest just Rs 6 lakh and use SIPs to increase your principal.

You will need to invest at least Rs 20000 through monthly SIPs to build up Rs 10 lakh in two years. You should invest only in short-term funds, as longer duration funds have exit loads of more than 12 months. Short-term funds may generate returns lower than 9 per cent (post-tax). 

You could also use a loan to achieve your goal, instead of increasing your corpus. Your EMIs will be less than your monthly SIPs, as your monthly payments will be made over two years instead of one. However, the current interest rates for vehicle loans are more than 10 per cent. Therefore, your loan repayment rate will be higher than the rate of return on your investment of Rs 6 lakh. Your personal balance sheet will show an increment on the liability side.

In conclusion, the most economically viable option is to increase your corpus (either by investing Rs 8.5 lakh today or by investing Rs 6 lakh and using SIPs to build up Rs 2.5 lakh). However, feasibility should be a priority as other factors may influence your decision.

 

Find More Articles on: DSIJ Magazine, Financial Guidance, Product, Large Cap, Personal Finance, Mutual Funds

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