A less-known Investment Method: Mutual Fund SIP in Debt Funds

What is the best way to optimize my investment portfolio? How can I survive when the equity market is going down? Is there any fixed income scheme available better than the traditional FDs or RDs?

The fixed income investment scheme which has got low risk and predictable returns is preferred by all kinds of investors. Safety, security and low risk are the key factors people look out for while choosing any investment option, right?

Let us look at how one can be benefited by investing in Mutual Fund SIP in debt funds.

Table of Contents:

1.Mutual fund SIP in Debt Fund – How do they work?

• What is a Debt fund?
• Gaining from falling interest rates
• Gaining from raising interest rates
• Investment time horizon and Duration of the Fund
• Using mutual fund SIP in debt fund to save on tax

2. Suitability of the Debt Mutual Fund SIP

3. Low-risk sip plans

i.) Debt Mutual Funds

• Liquid Funds
• Short-Term Debt Funds
• Gilt Funds

ii.) Important factors to consider when choosing low-risk SIP plans

4. RD vs Debt Mutual Fund SIP

• RDs (Recurring Deposits)
• Debt Mutual Fund SIPs (Systematic Investment Plans)

5. Which debt fund is best to invest?

i.) Popular categories of debt funds

• Liquid Funds
• Short Duration Funds
• Corporate Bond Funds
• Banking and PSU Funds
• Dynamic Bond Funds
• Gilt Funds

6. Factors to consider when choosing a debt fund

7. Additional tips for choosing a debt fund

Mutual fund SIP in Debt Fund – How do they work?

What is a Debt fund?

Debt fund is a type of mutual fund which in turn will invest in fixed income yielding instruments like Govt. securities, debentures bonds, commercial paper, treasury bills and the like. As they are not investing in stock market, the risk is very low in debt funds.

Mutual fund SIP in debt fund is the systematic approach of investing in debt mutual funds by means of fixed sum of money periodically.

Gaining from falling interest rates:

You will be amazed to know that even during global economic crisis in 2008; the debt funds like long term gilt government sector funds gave up to 28% return on investments.

When the interest rate falls, the reduced interest rates will be applicable only to the fresh investments. So the existing fixed income investments held by the debt funds will carry the old higher rate than the current market rate. As the debt fund portfolio has got higher rate than the market rate, the debt securities in the portfolio will be traded at premium. Because of this premium, you will gain as a debt fund investor.

Gaining from raising interest rates:

If the interest rate goes up, if you have locked your funds in long term fixed deposits or RDs you will continue to get the earlier lower rate. With Debt Mutual Fund SIP, your fresh investments will have better returns.

Investment time horizon and Duration of the Fund:

Choose a debt fund which will not change the duration vastly and frequently. You need to choose a fund which maintains the duration in a particular range at any given point of time.

Also match your investment time horizon with the duration of the fund.

If you follow the above 2 steps, it will help you avoid the interest rate risk, A debt fund selected this way will most likely to beat the similar FD returns.

Using mutual fund SIP in debt fund to save on tax:

There are tax free dividends offered while investing on mutual fund SIPs in debt fund. For example, FD interest taxable at the rate of 10/20/30% slab rate but the CG tax on debt funds is 10% flat or 20% with indexation. Highly beneficial for people in higher tax brackets.

Suitability of the Debt Mutual Fund SIP:

A.) Debt Mutual fund SIPs are suitable for short term investments.
B.) Debt Mutual fund SIPs are suitable for maintaining liquidity.
C.) Debt Mutual Fund SIPs are better alternatives to FDs and RDs.
D.) Debt Mutual Fund SIPs are suitable for risk averse investors.
E.) Debt Mutual Fund SIPs are the right place to build our emergency reserve.

Remember a key point here. Do not limit your investment only with equity market. By doing so, your investments are put to more risks that are attached to the unpredictable nature of the equity market. Consider investing on mutual fund SIPs in debt funds along with equity funds to reduce and diversify your overall risk.

Low-risk sip plans:

Low-risk SIP (Systematic Investment Plan) plans are a great way for young adults in India, or anyone with a low-risk tolerance, to invest and grow their wealth gradually over time. Here are some popular low-risk SIP options to consider:

A.) Debt Mutual Funds:

Type: These funds invest in fixed-income securities like government bonds, corporate bonds, and treasury bills.

Benefits:

Lower risk: Compared to equity mutual funds, debt funds offer lower volatility and are less susceptible to market fluctuations.

Steady returns: Debt funds offer predictable and consistent returns, making them suitable for building an emergency fund or saving for short-term goals.

Tax benefits: Debt funds held for over 3 years (income option) are taxed at a concessional rate compared to equity funds.

Here are some Debt Fund SIP options to consider:

B.) Liquid Funds:

Invest in very short-term debt instruments offering high liquidity and low volatility. Suitable for emergency funds or short-term goals within 3 years.

C.) Short-Term Debt Funds:

Invest in debt instruments with maturities up to 3 years. Offer a balance between stability and slightly higher returns compared to liquid funds.

D.) Gilt Funds:

Invest primarily in government bonds, offering high safety and predictable returns but may be slightly less liquid compared to other debt funds.

Important factors to consider when choosing low-risk SIP plans:

Investment Horizon: Match your SIP investment with your financial goals. Short-term goals (less than 3 years) may be suited for liquid funds or FDs. Long-term goals can benefit from short-term or gilt debt funds.

Expense Ratio: expense ratios mean more money goes towards your returns.

Credit Quality: For debt funds, consider the credit quality of the underlying bonds (higher credit rating indicates lower risk).

Tax Implications: Understand the tax implications of different debt fund options.

Remember: Low-risk SIP plans offer lower potential returns compared to equity-based options. However, they provide stability and are a good starting point for young investors or those with a low-risk tolerance. Consider consulting a financial advisor for personalized advice on choosing the best low-risk SIP plan for your needs.

RD vs Debt Mutual Fund SIP

Here’s a breakdown comparing Recurring Deposits (RDs) and Debt Mutual Fund SIPs to help you decide which is better for you:

RDs (Recurring Deposits):

Features:

• Offered by banks and financial institutions.
• Fixed interest rate for the chosen tenure.
• Regular deposits (usually monthly) of a fixed amount.
• Guaranteed returns and low risk.
• Early withdrawal penalties may apply.
• Interest earned is taxable.

Benefits:

• Safe and predictable: Ideal for risk-averse investors or short-term goals.
• Disciplined saving: Encourages regular saving habits.
• Flexibility in deposits: Some banks allow skipping or increasing deposits within limits.
• Liquidity: Premature withdrawal options available (though with penalties).

Drawbacks:

• Lower potential returns: Compared to equity or debt mutual funds.
• Interest rate risk: Returns may not keep pace with inflation in the long run.
• Limited growth potential: Fixed interest rates don’t benefit from compounding like mutual funds.

Debt Mutual Fund SIPs (Systematic Investment Plans):

Features:

• Invest in a basket of fixed-income securities like bonds and treasury bills.
• Invest a fixed amount at regular intervals (usually monthly).
• Professionally managed by fund managers.
• Potential for higher returns compared to RDs.
• Subject to market fluctuations (lower volatility compared to equity funds).

Benefits:

• Higher potential returns: Can outperform RDs over the long term due to compounding.
• Diversification: Invested across various debt instruments, mitigating risk.
• Rupee-cost averaging: SIPs help average out the cost of investment units through market cycles.

Exemption from TDS:

Debt Mutual Funds offer the advantage of exemption from TDS (Tax Deducted at Source), unlike Bank FDs where TDS is deducted on interest income exceeding a certain threshold. To avoid TDS deduction in FDs, individuals need to submit Form 15G or Form 15H if their taxable income falls below the specified limit.

Loss Set-Off Benefit:

Capital gains from Debt Mutual Funds can be offset against capital losses incurred from stocks or other investments. This offsetting advantage is not available with FD investments.

Tax Deferral:

Unlike FDs where interest income is taxed annually, taxation in Debt Mutual Funds is deferred until redemption. Taxation only occurs upon redemption, allowing investors to defer tax payment and potentially benefit from lower tax liabilities.

“Read more about investing in debt funds after new taxation policies” Should You Invest in Debt Funds After New Taxation?

Drawbacks:

• Market risk: Returns can fluctuate compared to RDs.
• No guaranteed returns: Unlike RDs, there’s no guarantee of returns.
• Investment horizon: Requires a longer investment horizon (ideally 3-5 years or more) to benefit from compounding.
• Exit load: Some debt funds may have exit loads for withdrawals within a specific period.

Choosing Between RDs and Debt Mutual Fund SIPs:

• Risk Tolerance: If you prioritize safety and guaranteed returns, RDs are suitable. For potentially higher returns with some market risk, consider Debt Mutual Fund SIPs.
• Investment Horizon: RDs are better for short-term goals (less than 3 years). Debt Mutual Fund SIPs benefit from a longer investment horizon (3-5 years or more).
• Financial Goals: RDs are suitable for emergency funds or short-term saving needs. Debt Mutual Fund SIPs can be used for long-term goals like retirement or a down payment on a house.

Both RDs and Debt Mutual Fund SIPs have their advantages. Consider your risk tolerance, investment horizon, and financial goals to make an informed decision. You can even consider a combination of both for a balanced approach. Consulting a financial advisor can help you choose the investment option that best aligns with your unique financial situation.

Which debt fund is best to invest?

Choosing the best debt fund depends on various factors such as your investment goals, risk tolerance, investment horizon, and prevailing market conditions.

Here are some popular categories of debt funds:

A) Liquid Funds:

Suitable for short-term investments with high liquidity and low volatility.

B) Short Duration Funds:

Ideal for investors with a short to medium-term investment horizon seeking relatively stable returns.

C)  Corporate Bond Funds:

Invest primarily in corporate bonds, offering potentially higher returns than government securities with slightly higher risk.

D) Banking and PSU Funds:

Invest in debt instruments issued by banks and public sector undertakings, offering relatively stable returns with low credit risk.

E) Dynamic Bond Funds:

Provide flexibility to the fund manager to adjust the portfolio duration based on interest rate movements, suitable for investors seeking opportunities across different maturity profiles.

F) Gilt Funds:

Invest in government securities, offering relatively lower credit risk but susceptible to interest rate risk.

Factors to consider when choosing a debt fund:

Here are some factors to consider when choosing a debt fund:

i.) Investment horizon:

How long do you plan to invest the money? Short-term debt funds are generally less risky than long-term debt funds, but they also tend to offer lower returns.

ii.) Risk tolerance:

How much risk are you comfortable with? Debt funds are generally considered to be less risky than equity funds, but there is still some risk involved.

iii.) Investment goals:

What are you saving for? If you are saving for a short-term goal, such as a down payment on a house, you may want to choose a less risky debt fund. If you are saving for a long-term goal, such as retirement, you may be able to tolerate a more risky debt fund.

Here are some additional tips for choosing a debt fund:

• Invest in a diversified fund: This will help to reduce your risk.
• Consider the expense ratio: The expense ratio is the annual fee that is charged by the mutual fund company. Lower expense ratios are generally better.
• Don’t chase past performance: Just because a debt fund has performed well in the past does not mean that it will perform well in the future.
• Financial advisors: A financial advisor can help you choose a debt fund that is right for your individual needs and circumstances.

If you are REALLY inclined to make this solid difference in achieving your financial goals by creating a financial plan, then I would suggest you to test-drive our services by opting for