Debt mutual funds invest in fixed income securities like bonds, treasury bills, government securities, Money Market Instruments, and any other debt instruments. Such debt mutual funds are available in the form of Monthly Income Plans (MIP), GILT funds, Fixed Maturity Plans (FMP) etc.
Debt Mutual Funds are different from regular equity mutual funds and offer various other advantages which seldom are known. This article will sum up everything with respect to Debt Mutual Funds and its relevance in current scenario.
How debt funds are advantageous and when?
Capital gains are long term only if the debt mutual funds are held for 3 years or more. If you want efficient-taxability of the capital gains on mutual funds, then you can be invested in mutual funds for the period of 3 years or more. Such long-term capital gains are allowed benefit of indexation and 20% tax rate is applied after such indexation. Hence, these funds can be used as tax management tool for those who are in high tax bracket.
Market linked returns
Debt mutual funds generate superior returns as compared to other conventional fixed income securities, especially where the interest rates are falling. Reserve Bank of India is cutting rates from quite some time now and in recent monetary policy it changed it’s accommodative stance to neutral by keeping repo rate unchanged at 4%. Looking at falling interest rate scenario, we have experienced that this has resulted in reduction of interest rates of bank fixed deposits. On the contrary bond prices have risen as they have inverse relationship with interest rates. This will lead to increase in returns from the debt mutual funds. Since there won’t be major interest rate rise in coming future, debt mutual funds can be a safe bet for risk adverse investors to earn better returns as against bank fixed deposits etc.
Better liquidity as compared to bank deposits
Bank deposits are not transferable and cannot be withdrawn partially or even are levied premature withdrawal charges for premature full withdrawal. Debt mutual funds stand in a better position with respect to liquidity as it can be partially redeemed or withdrawn. However, keep a check on exit load within lock in period which may be between 6 months to 3 years. Some of the debt funds levy exit load of 0.5% to 2%, if redeemed or sold within lock in period.
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Superior returns and moderate risk
Since, falling interest rates make debt fund returns look good, these funds can even give you more than bank fixed or recurring deposits, at slightly higher risk than conventional bank deposits (due to interest rate risk).
Even in case of global economy impact on domestic economy, the investor can minimize such incidence of global recession or slow down, where FII may take out capital and returns from equity market and flee. This may result in chaos in stock markets and ultimately hamper your equity related mutual funds. So, you can stay safe by investing in debt mutual funds, which may fetch lower returns as compared to equity funds (but higher than conventional bank deposits) but may be a lot safer.
Current economic situation and Debt mutual funds
Pause on Rate cut by RBI
In the current scenario where RBI has put a hold on further rate cut in recent announcement of monetary policy, What should you do as a Debt Mutual Fund investor?
How will it impact Debt Mutual Funds?
Well, debt market will not be impacted much and looking at falling interest rates as RBI has already cut 115 basis points starting this year and is expected to reduce further in future, it is suggested to focus on shorter duration funds, corporate bond funds, banking funds, PSU funds. Also, stick to AAA funds.
As RBI consecutively been implementing the Repo rate cut, resulting the interest rate to fall. This has resulted in downward trend in bank deposit rates and any other conventional investment instrument return rate (which is linked to Repo rate). Currently, bank allows interest rate of 6.5-7% interest rate, maximum interest rate on deposits being 7-7.65% for senior citizens. This situation is perfectly ideal for investment in debt funds as it is moderate risk investment alternative but with superior returns as compared to bank deposits.
Global slow down owing to COVID-19
As stated by RBI governor,”Global economic activity has remained fragile; surge in COVID-19 cases has subdued early signs of revival.”
The stock market in recent time has been very volatile. This economic slowdown owing majorly to lockdown amid COVID-19 and volatile stock market is making many investors nervous and confused about their investments.
Foreign Institutional Investors (FII) are the entities which are affected the most by the market trends and economic changes. So whenever, stock market is going through volatile phase, FII will sell out, causing the stock market to come down even further. This will disrupt the equity linked mutual funds, so this is a right time to go for debt mutual funds amid uncertainity, since these funds invest in government securities and other fixed income securities.