10 Things You Must Know about Debt Mutual Funds
08 Jun 2017
Priyanka Sharma
New Page 1
"Mutual Funds are subject to market risks. Please read the offer
documents carefully before investing"
Did you pay heed to these cautionary lines blasted at you in all the
different modes of advertisements for mutual funds? The answer perhaps for most of us is
NO. These statements are generally not paid heed to while reading, watching or hearing an
advertisement nor during buying a bond. This article will guide you through the nuts and
bolts of the debt mutual fund subject, helping you to understand the market risks and
buying funds post a thorough knowledge.
People are generally more inclined to invest in the traditional
investment options like FDs, NSC or Time deposits. One of the very important aspect of
investment easily sidelined is – DEBT MUTUAL FUNDS.
Deft funds are mutual funds that are invested in fixed income
securities like bonds, treasury bills, government securities and money market instruments.
Debt mutual funds are short termed low risk and with good returns.
Let’s learn its 10 salient features which makes debt funds a good
investment opportunity for investors.
LOW RISK FACTOR:
Debt funds are the most reliable investment option for investors with a
low risk appetite. Investors who invest in debt funds are assured of no loss. The returns
on the debt funds are not high as equity funds and the risk factor is relatively very low.
The only possibility of risk is when the interest rates are hiked and that is a remote
possibility. There is an inverse relation between the bond prices and interest rates and
debt funds are affected by it which is reflected in their prices.
TAX FREE:
Dividend received from a debt fund is tax free in the hands of the
investor. Debt funds held for more than 3 years are considered as long term and taxed at
20% after indexation. Indexation takes inflation into account and reduces the tax on
capital gains. TDS isn’t deducted on gains.
TYPES OF DEBT FUNDS:
Debt funds are classified into 2 categories based on the duration and
time of their sell and purchase. They are viz. OPEN ENDED FUNDS and CLOSED ENDED FUNDS
Open-Ended Funds - Like equity, there are open-ended schemes where one
can sell or repurchase units in a fund throughout the year. Short Term Funds, Income
funds, Gilt Funds, MIPs all are part of this category.
Closed-Ended Funds - Some of the debt schemes are closed-ended where
one can invest only during the NFO of the product post which the scheme is closed for
investment. The scheme matures after a specified period and the liquidity to exit is low.
The only exit option available to the investor is selling it in the stock exchange where
these funds get listed. Fixed Maturity Plans, Capital Protection Funds are a part of this
category.
TYPES OF DEBT FUNDS BASED ON RISKS:
Liquid Funds – They are very low risk funds. These funds invest in
highly liquid money market instruments. They invest in securities with a residual maturity
of not more than 91 days. Investors can park their money in them for a few days to few
months. These funds offer marginally higher returns than bank deposits.
Ultra Short-Term funds are low risk funds. These funds invest mostly in
very short-term debt securities and a small portion in longer-term debt securities.
Investors can park their money for a few months to a year in them. The category has
offered 8.58 per cent in the last one year.
Fixed Maturity Plans are a good alternative to fixed deposits for
investors in the higher tax bracket. These are closed-ended debt mutual funds. These funds
invest in debt instruments with less than or equal to the maturity date of the scheme.
Securities are redeemed on or before maturity and proceeds are paid to the investors.
Returns from them depend on the prevailing rates in the money market.
Short-Term Funds invest mostly in debt securities with an average
maturity of one to three years. These funds perform well when short term interest rates
are high. These are suitable to invest within a horizon of few years. The category has
generated returns of 9.37 per cent in the past year.
Dynamic Bond Funds have an actively-managed portfolio that varies
dynamically with the interest rate view of the fund manager. These funds invest across all
classes.
MODIFIED TAX RULES:
The minimum tenure for capital gains have been increased from 1 year to
3 years, which means the investor has to remain invested for 3 years to redeem the low tax
benefits over the capital. If redeemed within three years, the gains will be added to the
person's income and taxed as per the applicable income tax slab. But if the investor holds
the units for more than the tenure, the debt fund will be more tax-efficient than FD.
MARKET LINKED RETURNS:
Even though the debt funds seem to be very lucrative in nature, they do
not guarantee assured returns. Debts funds are volatile in nature and this is defined by
the maturity profile of the holdings. Funds holding short-term bonds are not very volatile
and give returns roughly equivalent to the prevailing interest rate.
Funds that invest in long-term bonds are more sensitive to changes in interest rates. If
the rates decline, the values of bonds in their portfolio shoot up leading to capital
gains for the investor.
INVEST IN SIPs THROUGH DEBT FUND:
Investors with a large sum to invest should opt for debt fund through
the systematic investment plan (SIP) that allows an investor to invest in funds of their
choice. Every month a fixed amount from the investor’s account is transferred to
equity scheme.
For those nearing the retirement age should consider investing in a
debt fund to enjoy a monthly gain. The monthly capital gain on the debt fund can be
attained through the systematic withdrawal plan.
INVESTMENT TRANSPARENCY:
In a debt mutual fund, investors enjoy the facility of receiving the
exact portfolio with respect to where the money is invested on a monthly basis with a
minimum cost. This helps investors in evaluating the choice of investment with regards to
the debt fund.
DIVIDENDS:
Debt mutual funds give the investors the liberty to choose the
dividend, however these aren’t guaranteed.
EXIT LOAD:
Debts funds can be easily exited with the amount invested deposited in
the investor’s bank account within a day or two of withdrawal. Please note that
certain funds impose a penalty on investors for exiting the fund 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. Verify the exit load of the fund before you invest. Even a
1% exit load can shave off a significant portion from your profits.
Still looking to invest in debt mutual funds? Don’t forget to read the terms and
conditions carefully and make a smart choice with the information provided.