Let us address the first question: should you invest in debt schemes just to claim the old favourable taxation? According to the amendment, the indexation benefit and LTCG tax won’t be available to debt investors on investments made after April 1. Earlier, debt mutual fund investments held over three years were taxed at 20% with indexation benefit. The indexation used to help to bring down the taxes, especially in an inflationary environment. Mutual fund advisors say investors used to pay low single-digit taxes. Now you may understand why investors are going to miss LTCG tax with indexation benefits. From the next financial year, debt mutual funds will be taxed according to the applicable individual income tax slabs.
Coming back to the question whether you should invest in debt schemes before April 1, we believe investors should not base investment decisions only on taxes. You should always base your investment decisions and choose your investment options on your goals, investment horizon and risk profile. For example, if you are investing for a short period of, say, one or two years, you should invest in bank deposits or debt mutual funds. You don’t have much of an option here. This is because when you are investing for a short period, your priority should always be to protect your capital. In other words, safety of your investment should be your priority. That means you should not take risks and invest the money in risky options. If you want to take care of your short-term goals.
Simply put, you should always think about your financial goal, how much time you have to achieve it, and how much risk you are willing to take before taking a call on investment. Don’t forget these factors and focus solely on LTCG tax and indexation benefits. That will result in wrong investment choices and sub-optimal returns.
Now let us move to the second part of the question: which debt mutual funds should you invest? As we discussed earlier, your investment choices are always dictated by your goals, horizons and risk appetite. For example, if you are investing for a few days, you don’t have an option other than investing in liquid funds. If you are investing for a few months up to a year, your choice will be ultra short term funds. If you are investing for three years, you can invest in corporate bond funds, banking & PSU bond funds, dynamic bond funds, etc. We would not recommend investing in long duration funds and gilt funds. These schemes are extremely risky as they are very sensitive to interest rate changes. Regular investors would find it difficult to deal with the volatility and keep track of interest rate movements.You can look at the Sebi definition of (see the accompanying table) and figure out how you can match your investment horizons with these schemes.
To sum up, don’t focus on taxation to make investment choices. Always choose your options based on your goals, investment horizons and risk profile.
Overnight Fund: Investment in overnight securities with maturity of one day
Liquid Fund: Investment in debt and money market securities with maturity of up to 91 days
Ultra Short Duration Fund: Investment in Debt & Money Market Instruments such that the Macaulay duration of the portfolio is between 3 and 6 months
Low Duration Fund: Investment in Debt & Money Market Instruments with Macaulay duration of the portfolio between 6 to 12 months
Money Market Fund: Investment in Money Market instruments having maturity upto 1 year
Short Duration Fund: Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 1 year – 3 years
Medium Duration Fund: Investment in Debt & Money Market instruments such that the Macaulay duration is between 3-4 years.
Medium to Long Duration Fund: Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 4 – 7 years
Long Duration Fund: Investment in Debt & Money Market Instruments such that the Macaulay duration of the portfolio is greater than 7 years
Dynamic Bond : Investment across duration
Corporate Bond Fund : Minimum investment in corporate bonds – 80% of total assets (only in highest rated instruments) bonds
Credit Risk Fund: Minimum investment in corporate bonds – 65% of total assets( investment in below highest rated instruments)
Banking and PSU Fund : Minimum investment in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions -80% of total assets
Gilt Fund: Minimum investment in G-secs – 80% of total assets (across maturity)
Gilt Fund with 10-year constant duration: Minimum investment in G-secs – 80% of total assets such that the Macaulay duration of the portfolio is equal to 10 years
Floater Fund: Minimum investment in floating rate instruments -65% of total assets
