What are the various options for an investor in debt funds?
Based on an investor’s risk appetite and time frame of investment, an investor can choose from various categories of
debt mutual fund that are available. Investors with a short time frame of 1 day to three months, can use overnight /liquid funds, those with a time frame of 3 months to a year can use ultra short-term funds, those with time frame of 1-3 years can use short-term funds or medium duration, corporate bond funds. Investors looking to capitalise on a fall in interest rates and earn a capital appreciation can use long tenure Gsec funds that have a maturity upwards of 3 years. Those eyeing visibility of returns can choose a target maturity fund.How do these funds earn a return?
A debt scheme earns in two ways namely interest payments from its bond holdings which generates
accrual income. Secondly, as and when interest rates fall/rise, bond prices move up/ down resulting in capital gains/loss. Both the gains combined together is the final return for the investor. The capital gain/loss component is also called the mark-to-market (MTM) return.
What are the advantages?
Debt funds enjoy high liquidity. A redemption request once placed before the cut off time, ensures money comes into your bank account on next working day. One can switch among various debt schemes anytime based on changing requirements. In a fixed deposit, if one needs money in an emergency, she needs to break the full deposit. While in a debt fund, one can redeem the required number of units or amount. Most banks levy a prepayment penalty on fixed deposits if withdrawn before the maturity date. There is no such penalty in debt funds. When interest rates begin to fall, there is a scope of capital appreciation in a debt fund, which does not exist in other fixed income products. Investors can redeem small amounts.
How these funds are taxed?
From April 1, 2023, debt mutual funds are taxed like other fixed income products. Capital gains earned from such schemes shall be taxed as per the income tax slab applicable to the individual and there will be no long-term capital gains or indexation benefits.
