Thursday, 4 June 2015

5 Smart Things to Know About Debt Mutual Funds

Posted by MyInvestmentsPub
The current buzz word in the Market is RBI's rate cut. Many experts believing that the interest rates would come down further to make a room for the growth. The current atmosphere is also favorable to rate cut as the inflation rate is under control, the crude oil prices are less, Industrial growth is not encouraging. These factors would definitely encourages RBI to make a further rate cut. This situation would make favorable to Debt Mutual Funds, because if interest rates decline, the value of bonds in their portfolio shoots up, leading to capital gains for the investor. We will know 5 smart things about Debt Mutual Funds which would benefit to you in this article...


What are Debt Mutual Funds?

Debt mutual funds are those products which invest in mix of fixed income securities like government bonds, corporate deposits, treasury bills, money market instruments with different maturity and interest rates. The objective of these funds is to generate regular income with capital appreciation over the period.

How does debt fund works?

Debt mutual fund schemes hold many fixed income instruments based upon the objective of the scheme. It’s more like a basket of debt securities with different maturity and interest rate. Typically, a bond fund manager selects the securities which are highly rated. This also improves the credibility of the fund. The regular change in the interest rate impacts the price of the security. When the interest rates are in downtrend, the price of the security appreciates and vice versa. A role of a fund manager is to generate regular income from time to time by leveraging the interest rate movement.

When to Choose Debt Mutual Funds:

  • Your goals are less than 5 years away; or
  • Your growth objectives will be met with a lower (8-9%) rate of return; or
  • You are not comfortable with volatility and willing to adjust your growth expectations accordingly.

5 Smart Things to Know About Debt Mutual Funds:

1. Long Term Capital Gain Tenure:


In the current year's Budget, the taxation rules for Debt Mutual funds were changed. The minimum tenure for long-term capital gains was extended from 1 to 3 years. This means that investors will have to remain invested for at least 3 years if they want the benefit of lower tax on long-term capital gains. If redeemed within 3 years, the gains from the funds will be added to the individual's income and taxed as per the applicable income tax slab. However, if the investor can hold for more than 3 years, a debt fund will be far more tax-efficient than an FD. In an FD, the entire interest earned is taxed at the rate applicable to the investor. The long-term capital gains from debt funds are taxed at 20% after indexation. Indexation takes into account inflation during the period that the investment is held by investor and accordingly adjusts the buying price. This can lower the capital gains tax significantly.

2. Highest Post Tax Returns and No TDS:


Another tax-friendly feature of Debt Mutual funds is that there is no tax deduction at source (TDS) on the gains. In FDs, if your interest income exceeds Rs 10,000 a year, the bank will deduct 10.3% from this income. If you are not liable to pay tax, you will have to submit either Form 15H or 15G to escape TDS. The other problem is that the income from fixed deposits is taxed on an annual basis.
You will get the money once the deposit matures, but the income is taxed every year. In Debt Mutual funds, the tax is deferred indefinitely till the investor redeems his units. What's more, the gains from a Debt Mutual fund can be set off against short-term and long-term capital losses you may have suffered in other investments.

3. Returns are market-linked but Higher Safety of Capital:


The returns of Debt Mutual funds are Market linked to some extent, but the Safety of Capital is higher when compared to Equity Mutual funds. The Debt Mutual funds can churn out some losses if the interest rates go up, although the possibility of this happening is remote. The maturity profile of the holdings defines the volatility of a debt fund. Funds holding short-term bonds are not very volatile and give returns roughly equivalent to the prevailing interest rates. With careful analysis, you can pick debt funds whose portfolio has a combined credit risk almost at par with FDs. But the funds that invest in long-term bonds are more sensitive to changes in interest rates. If rates decline, the value of bonds in their portfolio shoots up, leading to capital gains for the investor. While the average short-term debt fund has given 9% - 10% returns in the past couple of years, some long-term bond funds have shot up by 14-15% during the same period.

4. SIPs are the Best way to Buy Debt Mutual Funds:


To maximize your returns from Mutual funds is through Systematic Investment Plan (SIP). This is applicable to Debt Mutual funds also. If you have a large sum to invest, put it in a debt fund and start a systematic transfer plan to the equity fund of your choice. Every month, a fixed sum will flow out from the debt fund into the equity scheme. Compared to the 4% your money would have earned in the savings bank account, it has the potential to earn 9-10% in the debt fund. Similarly, if you want regular retirement income from your investments, invest in a debt fund and start a systematic withdrawal plan. Every month a fixed sum will be redeemed from your investment.

5. Exit load is a matter:


A debt fund is very liquid since you can withdraw your investments at any time and the money is in your bank account within a day. However, some funds levy a penalty for exiting before the minimum period. The exit load can vary from 0.5% to 2%, while the minimum period can range from six months to up to two years. Check the exit load of the fund before you invest. Even a 1% exit load can shave off a significant portion from your gains.

Conclusion:

Debt Mutual Funds are the most preferable investment option to fulfill your short-term goals. You should keep on investing for at least 3+  years to maximize the benefits from Debt Mutual funds. 

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