In my previous article, I have explained everything about Debt Funds, Types of Debt Funds, and How to chose correct debt funds for the balanced portfolio. In this article, I will be explaining the top 5 benefits of debt funds so that you could make informed investment decisions.
Debt Funds are used as an alternative investment instrument to a savings account and fixed deposits. Interest rates of fixed deposit and savings accounts have come down drastically and it is difficult to beat the inflation with such returns. Therefore, investors are actively looking for other investment opportunities like Debt Funds which as safe like fixed deposits but can generate more returns. Let’s get started.
What is a Debt Fund?
Debt Funds or Debt Mutual Funds are the fund houses that pools out money from the many investors and invest that money into fixed income-generating securities. SEBI has categorized the debt funds into 16 types based on different maturity horizon and securities these funds invests in.
Debt Funds are a safe investment than equity mutual funds because their investments are in Corporate Bonds, Debentures, and Government Securities. Corporate Bonds are issued by companies, Debentures are issued by financial institutions and Government Securities are issued by the Government.
These debt funds are not generating better returns than the equity-focused mutual funds but they generate steady and consistent returns. This makes it safer and alternative to a fixed deposit scheme. Unlike mutual funds, debt funds are less-risky and deliver stable returns. The maturity of Investments of a Debt Fund is similar to the maturity of that fund i.e. if a Debt Fund is an overnight fund then they will invest only in government treasury bills which has the maturity of a single day. This reduces the risk of fluctuation of investment return.
Benefits of Debt Funds
Debt funds invest in securities that are rated by the credit rating agencies based on their past performance and perceived value. This guarantees the safe investment, however, following are the key benefits of investing in Debt Mutual Funds that every investor should know;
1. Flexible Investment Horizon
There are a total of 16 types of bonds and they offer different investment time horizons based on your investment goals. In a debt fund, you can invest money for a overnight and enjoy the quick returns. Read my previous article where I have explained all types of Debt Funds with their maturity horizon.
2. Exposure To Investment in Corporate Bonds & Commercial Papers
The Debt Funds invest money in Commercial Papers, Corporate Bonds, Debentures, and Government Securities. Corporate Bonds and Commercial Papers are issued by companies, Debentures are issued by financial institutions and Government Securities are issued by the Government.
It is not possible to invest in these kinds of bonds due to the minimum fund requirement. Even if an investor buys directly these bonds, then it will be a huge and concentrated risk. On the other hand, Debt Funds diversify their investment by investing in multiple bonds. Therefore, debt funds are the best way to invest in Commercial Papers and Corporate Bonds.
Taxation applicable to Debt Funds only after the maturity, unlike Fixed Deposit where you have to pay tax every year if returns are more than INR 40000. Taxation on other investments is based on your income tax slab however, in Debt Fund, it would be flat 20% if invested for more than 3 years. You can access the FD and Debt Fund Returns Coparision calculator in excel.
4. Benefit Of Indexation
Debt Funds get the benefit of indexation in invested for more than 3 years. This adds more return and reduces the taxable money to adjust the inflation rate. It is being calculated by using the Cost Inflation Index i.e. CII.
For example, if you had invested INR 1,00,000 in 2010 when the CII values were 110 and your maturity amount after 3 years was INR 1,20,000 and the CII value was 130. Here your taxable profit is INR 20,000 for other investment instruments but Debt Funds gets the benefit of Indexation here.
Inflation-Adjusted Initial Investment Amount will be calculated by dividing the CII value when the debt fund got matured from the CII value when the investment made then the resulted value will be multiplied to the initial amount for the taxation purpose. E.g. (130/110)*1,00,000 = INR 1,18,182. So, your tax return will be only INR 1818/- and 20% flat tax be applicable on this that is INR 363.6 only. Refer to this article to understand this better.
5. Safe Yet Attractive Returns
Debt Funds are as safe as Fixed Deposits however, there is no doubt that it cannot beat FD when it comes to the fixed rate of returns. Since Debt Funds are investing the collected money in other safe securities and returns could fluctuate based on market conditions, it cannot guarantee a fixed rate of returns. But, if you look at the past performances of Debt Funds, they all have performed well and have generated more return than FD or Savings Account.
Refer to the following debt fund performance example which has generated more than 8% annualized returns in three years even though there were some fluctuations during the journey.
There is no harm in saying that, the debt funds not only make your investment portfolio stable and predictable but also makes your debt exposure tax efficient.
- Why Debt Funds Are Better Than FD
- FD and Debt Fund Investment Returns Calculator
- Is FD Worth Investing In 2020?
These are my top 5 Benefits Of Debt Fund investment for you. Debt Funds are for all type of investor and fits well in all kind of investment portfolios. However, one should invest in the right Debt Fund based on the investment goals to get the most out of it. Do share your success story with the debt funds in the comment section.