Though debt funds have got their own advantages, they are mostly ignored by common investors. Debt funds have got a unique place in your portfolio. Here are five simple situations, in which debt funds can be used by prudent investors.
1) To meet the short term goal
If you have got goals, which you are planning to achieve in a short term like one year or 2 years, then debt funds are the ideal place to invest. Debt funds are less volatile when compared to equity funds. Also, you will have predictable returns. You also have a choice of different debts funds which can be matched to different short term horizons like 1 month, 6month, 9months, 1 year, 18 months, and so on.
You can’t take risks and invest your short term money in the stock market. You need to ensure safety and liquidity as far as short term investments are considered which is very much there in debt funds.
2) Any Time Money
Under some circumstances, you may not know when the need for the money will arise. But when the need arises, you may need the money at short notice. Say situations like the down payment money which you keep it when searching for a property.
Debt funds are the ideal place to keep our emergency reserve. Now days liquid funds of a few mutual fund companies come with debit card facilities. So you can keep your entire emergency reserves in these kinds of debt funds.
3) Lesser Tax than FDs
If you fall under the 20% or 30% tax bracket, then debt funds make more sense for you when compared to fixed deposits. The fixed deposit interest will be added to your income, and taxed at the tax bracket you are falling under.
In debt funds, there are two categories, Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG).
If the debt fund is withdrawn within three years of investment, it is Short Term Capital Gain and you will be taxed according to your income tax slab.
If the debt fund is withdrawn after 3 years of investment, it is Long Term Capital Gain and you will have to pay a 20% tax with indexation benefit,i.e. inflation index would be adjusted to the investment.
Eg: You invest Rs.15,000 in 2017 and your investments become Rs. 30,000 in 2020. Your capital gain is Rs.15,000. But you don’t have to pay tax for this whole amount as the inflation index is adjusted and so the capital gain reduces.
To find the indexed cost of acquisition, use the formula:
The original cost of acquisition * (CII for the year of sale / CII for the year of purchase)
= Rs.15000 * (289/264)
Your capital gains will now be Rs.13,580 (30,000-16,420). So you will be paying tax only on Rs.13,580. This is the indexation benefit.
The interest from fixed deposits will be taxed on accrual. Even on your cumulative deposit, you need to pay tax annually. As far as debt funds are considered, you will be taxed only when you actually redeem from the debt fund.
Here is an FD and Debt fund calculator to compare the returns from the fixed deposit and debt mutual funds.
Here are the workings of the calculator.
First type your investment amount, tenure, rate of return from FD, rate of returns from Debt Mutual Funds (Assumed), and then choose your tax slab.
Here below is the calculation by an investor, to find which gives better returns.
After typing the above details he will find the amount received after tax. The below details are automatically calculated.
Debt Mutual Funds Investment
Now you too can compare and find which gives better returns.
4) As a launching pad for large equity investments
If you are planning to invest a lump sum amount in equity funds, then it is generally suggested that you should not invest the lumpsum in equity funds at one go. You need to stagger your investments in order to take advantage of the volatile stock market. So as to stagger your equity investment, you can use the debt funds as a launching pad.
That is you can keep the entire money in a debt fund and slowly you can invest them into equity funds in a staggered manner. If you would like to do this staggering in a more systematic and sophisticated manner, you can opt for STP –systematic transfer plan. That is you can give a standing instruction to transfer a fixed sum from a debt fund to an equity fund periodically.
5) To generate regular income
If you would like to generate regular income then debt fund is one of the ideal investments for you. You can get regular income by way of choosing the dividend payout option.
One more way to generate regular income from debt funds is to opt for SWP from debt funds. SWP is a systematic withdrawal plan which is the reverse of the Systematic investment plan . From a large sum of investment, you can opt to withdraw the appreciation or a fixed sum on a regular basis.
Debt funds play an important role in anyone’s portfolio which can’t be replaced by any other investment vehicle. So, next time when you come across any of the above situations, make use of debt funds to your advantage.
To take advantage of the right investment schemes in the right situation, you should have a holistic financial plan with a complete big picture of your personal finance. To help you in the process of creating this financial plan, we offer