Things to keep in mind while investing in debt mutual fund

Representational image. PTI

Debt funds are the ideal investment instruments for investors who have a conservative approach and follow asset allocation. The core strategy of debt funds comprises of investing primarily into fixed income securities such as corporate bonds, government securities, bank CDs, and more. Stability is what debt funds bring into your portfolio. But before you take the plunge it is vital to know certain important aspects of investing in debt funds.

There are many types of debt funds based on tenure and credit. From overnight funds, liquid funds, ultra-short duration funds, money-market funds, short duration funds, medium to long duration funds and more there is a debt fund to cater to every type of investor need.

Debt funds are an ideal fit for investors who have parked their savings in bank deposits as debt funds have the potential to offer you higher returns. Compared to equity funds, debt funds are less risky owing to their strategic allocation to safe instruments. Debt funds are low-cost investments, tax-friendly, and easily redeemable.

Remember the ‘ABC of investing in debt funds’:

1. Unlike Equity Investing, which is for long term, Debt investing is suitable for all time frames.
2. Investing in Debt MF is all about Mathematics. If some basic rules are followed, the chances of going wrong are limited. In a scenario where the interest rates are flat, one should look to invest in funds whose duration is slightly lower than the investment horizon. Long duration funds tend to provide higher returns in a falling interest rate scenario, and in a rising interest rate invest short duration funds.
3. Interest rates have been very low in the last couple of years resulting in low accruals. With RBI raising rates since April 2022, returns were further impacted. RBI’s rate hike cycle is likely to peak in the next one or two quarters. Debt fund portfolios are currently yielding 7.25-7.50% and once RBI starts easing, there are chances of debt funds delivering even double-digit returns
4. The regulator has made it very simple for all of us after the introduction of scheme categorization.

Category                                                   Recommended investment horizon

Overnight                                                                     I day

Liquid                                                                           > 7 days

Ultra-short /Money Market                                          3-6 months

Low duration                                                                > 6 months

Short term /Corporate Debt                                         1-3 years

Debt Index (Target Maturity Funds)                             > 3 year 

5. Taxation: Short term capital gains (if the units are sold before three years) are taxed as per applicable tax rate of the investor. Therefore, if your tax rate is 30% then short-term capital gains tax on debt fund is 30% + 4% cess. Long term capital gains of debt funds are taxed at 20% with indexation benefits.

The pros outweigh the cons of investing in debt funds. Ideally, every portfolio should balance its risk with carefully chosen debt funds. Typically, debt investing is more popular in Corporate and super HNI clients because of its superior post tax return. However, even without the tax advantage, debt funds should be part of everyone portfolios given the multiple benefits they bring to investors.

The author is Chief Business Officer at Trust Mutual Fund. Views expressed are personal. 

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