Debt Funds

Debt Funds :

These are category of mutual funds that invest majorly in fixed income instruments like corporate debentures, bonds , certificate of deposit, treasury bills, gilts and commercial papers. Some debt mutual fund options are – Short term debt funds, Fixed Maturity Plan (FMP), Liquid funds, Dynamic bond funds and Gilt fund.

Listed below are the reasons that these funds should be preferred over other fixed income options :

1. More liquid than fixed deposits :
Some of debt funds like liquid funds can be withdrawn next day of investment itself without paying any charge. Some other have exit load for a period of 1 month to 9 month. So depending on the investment horizon customer can make a choice accordingly. Also, one can make partial withdrawal without affecting other part of investment.

2. They are more tax efficient :
When one invests in FD’s, return from them is taxable as per respective income tax slab. However taxation in debt fund is very much different. In debt fund long term capital gains tax (earning from a fund held for 365 days and above) without indexation is 10 %, while it is 20% with indexation. Short term capital gains tax is deducted according to one’s income tax slab. For example, please find below comparison where taxation has been done with indexation.

Title FDs Debt Fund
Investment 1000 1000
Return 9% 9%
Inflation 7% 7%
Cost of Purchase 1000 1070
Fund value 1090 1090
Capital Gain 90 20
Tax @ 30% 27 4
Post Tax Gains 1063 1086
Tax @ 20% 18 4
Post Tax Gains 1072 1086
Tax @ 10% 9 4
Post Tax Gains 1081 1086

3. You don’t even loose a day’s of growth :
Imagine a situation where you have invested money in a FD for a year. Once time comes for maturity because of your hectic time schedule you forgot to redeem / reinvest. Then for such time period you will not be getting the interest you deserve. In a debt fund you need not worry as it keeps on growing until you redeem the units.

4. Your returns can be higher :
Debt funds are sensitive to interest rate changes. In situations where interest rate declines then in long term debt funds pre tax returns can be significantly higher than those in FDs.

5. They offer greater flexibility :
One can invest in debt funds in the form of lumpsum (One time investment) or in the form of SIP. Not only investment you can also do a SWP which is systematically withdrawing your money at defined interval say monthly.