SIP In Debt Funds
Setting aside a fixed amount of money every month specifically for savings or investment is the best way to create wealth. For people willing to invest a fixed amount every month rather than a single time investment of huge amount, opening a RD, PPF or starting a SIP are the most preferred options.
Fixed Deposits have been a part of each and every Indian household. Our grandparents, parents have all ended up in investing in FDs. Whenever they had to save money for a goal, they put it in an FD. It was the best option to earn interest while ensuring capital protection.
The declining interest rate regime and the excessive liquidity caused by demonetization, higher savings and financial literacy have forced banks to reduce their FD interest rates to historic lows. This, in turn, is forcing investors to turn look for investment alternatives with higher returns whilst ensuring maximum safety of capital. But is there a more efficient way to earn?
Over the past few years, mutual funds are increasingly becoming a part of every one’s portfolio. A Debt Fund is a type of mutual fund which invests most of the money gathered from investors into fixed income instruments like Corporate Bonds, Government Bonds, Bonds issued by Banks, Certificate of Deposits, Treasury Bills etc. There are numerous benefits to investors doing SIPs in Debt Funds instead of traditional instruments like recurring deposits. Below are some of the most striking features.
Bank deposits are most likely one of the safest avenues for investors with an almost negligible chance of default. As with all mutual funds, there are no guarantees in debt funds either. Returns are market-linked, and the investor is fully exposed to defaults or any other credit problems in the entities whose bonds are being invested in. However, the MF industry is closely regulated and monitored by the regulator, Securities & Exchange Board of India (SEBI). Regulations put in place by SEBI keep tight reins on the risk profile of investments, concentration of risk in funds, valuation of investments and the compliance of funds with its goals. In the past, these measures have proved to be highly effective with very few adverse cases.
The other big difference is taxation. Returns from bank fixed deposits are Interest Income and as such have to be added to your Normal Income (as Income from Other Sources). Banks also deduct TDS on Interest Income from Fixed Deposits. When an investor has SIP in a Debt Fund and stays invested for at least 3 years, the Capital Gain is taxable with an Indexation Benefit and the Long-Term Capital Gain Tax payable is 20% which is far better than paying tax as per tax slab, especially when one is in the highest tax bracket. However, in case of debt mutual fund schemes, if the holding period is less than 3 years, the tax levied will be as per the tax slab. This is compensated by about 1-4% higher returns depending on the type of debt funds one invests in.
On redemption, open-ended debt funds proceeds are typically credited within a period of 2-3 working days. FDs are also available at 1-2 days’ notice, but usually, carry a heavy penalty if they are redeemed before the maturity date. Most banks currently deduct 1% from the original booked rate or 1% from the original card rate applicable for the period for which the FD has been in force, whichever is lower. These may adversely impact your FD’s effective rate of return in case of pre-mature withdrawal during emergencies. Also, there are penalties if you miss out on an investment in a committed Recurring Deposit.
Debt mutual funds, other than Fixed Maturity Plans, do not restrict redemption. However, many funds charge exit loads, ranging from 0.25–1% of the redeemed amount, if they are redeemed within a pre-specified period. Such periods can range anywhere from 15 days to 6 months. Ultra Short-Term and many short-term funds do not charge exit loads and are best suited to park any emergency fund.
Debt funds have almost always generated 1-4% higher returns than the average fixed or recurring deposit. Debt Fund investments take both credit risk (lending to riskier borrowers) and interest rate risk (the risk of bond prices falling when interest rates rise). Hence, such investments are compensated by higher returns. However, since debt funds invest in a diverse range of securities and are very tightly monitored, they probably offer the best risk-adjusted returns.
To summarize, Debt mutual funds are not riskier than bank deposits. For the average investor, a SIP in debt funds has more benefits in terms of higher returns, tax efficiency, liquidity and safety, compared to Recurring or Fixed Deposits. They key is to find the most efficient type of debt funds for your goals.
We advise you to contact your financial advisor and enjoy substantial returns while not taking any significant risks.
(The author is an investment consultant)