10 Things You Must Know about Debt Mutual Funds

"Mutual Funds are subject to market risks. Please read the offer documents carefully before investing"

Did you pay heed to these cautionary lines blasted at you in all the different modes of advertisements for mutual funds? The answer perhaps for most of us is NO. These statements are generally not paid heed to while reading, watching or hearing an advertisement nor during buying a bond. This article will guide you through the nuts and bolts of the debt mutual fund subject, helping you to understand the market risks and buying funds post a thorough knowledge.

People are generally more inclined to invest in the traditional investment options like FDs, NSC or Time deposits. One of the very important aspect of investment easily sidelined is – DEBT MUTUAL FUNDS.

Deft funds are mutual funds that are invested in fixed income securities like bonds, treasury bills, government securities and money market instruments. Debt mutual funds are short termed low risk and with good returns.

Let’s learn its 10 salient features which makes debt funds a good investment opportunity for investors.

LOW RISK FACTOR:

Debt funds are the most reliable investment option for investors with a low risk appetite. Investors who invest in debt funds are assured of no loss. The returns on the debt funds are not high as equity funds and the risk factor is relatively very low. The only possibility of risk is when the interest rates are hiked and that is a remote possibility. There is an inverse relation between the bond prices and interest rates and debt funds are affected by it which is reflected in their prices.

TAX FREE:

Dividend received from a debt fund is tax free in the hands of the investor. Debt funds held for more than 3 years are considered as long term and taxed at 20% after indexation. Indexation takes inflation into account and reduces the tax on capital gains. TDS isn’t deducted on gains.

TYPES OF DEBT FUNDS:

Debt funds are classified into 2 categories based on the duration and time of their sell and purchase. They are viz. OPEN ENDED FUNDS and CLOSED ENDED FUNDS

Open-Ended Funds - Like equity, there are open-ended schemes where one can sell or repurchase units in a fund throughout the year. Short Term Funds, Income funds, Gilt Funds, MIPs all are part of this category.

Closed-Ended Funds - Some of the debt schemes are closed-ended where one can invest only during the NFO of the product post which the scheme is closed for investment. The scheme matures after a specified period and the liquidity to exit is low. The only exit option available to the investor is selling it in the stock exchange where these funds get listed. Fixed Maturity Plans, Capital Protection Funds are a part of this category.

TYPES OF DEBT FUNDS BASED ON RISKS:

Liquid Funds – They are very low risk funds. These funds invest in highly liquid money market instruments. They invest in securities with a residual maturity of not more than 91 days. Investors can park their money in them for a few days to few months. These funds offer marginally higher returns than bank deposits.

Ultra Short-Term funds are low risk funds. These funds invest mostly in very short-term debt securities and a small portion in longer-term debt securities. Investors can park their money for a few months to a year in them. The category has offered 8.58 per cent in the last one year.

Fixed Maturity Plans are a good alternative to fixed deposits for investors in the higher tax bracket. These are closed-ended debt mutual funds. These funds invest in debt instruments with less than or equal to the maturity date of the scheme. Securities are redeemed on or before maturity and proceeds are paid to the investors. Returns from them depend on the prevailing rates in the money market.

Short-Term Funds invest mostly in debt securities with an average maturity of one to three years. These funds perform well when short term interest rates are high. These are suitable to invest within a horizon of few years. The category has generated returns of 9.37 per cent in the past year.

Dynamic Bond Funds have an actively-managed portfolio that varies dynamically with the interest rate view of the fund manager. These funds invest across all classes.

MODIFIED TAX RULES:

The minimum tenure for capital gains have been increased from 1 year to 3 years, which means the investor has to remain invested for 3 years to redeem the low tax benefits over the capital. If redeemed within three years, the gains will be added to the person's income and taxed as per the applicable income tax slab. But if the investor holds the units for more than the tenure, the debt fund will be more tax-efficient than FD.

MARKET LINKED RETURNS:

Even though the debt funds seem to be very lucrative in nature, they do not guarantee assured returns. Debts funds are volatile in nature and this is defined by the maturity profile of the holdings. Funds holding short-term bonds are not very volatile and give returns roughly equivalent to the prevailing interest rate.

Funds that invest in long-term bonds are more sensitive to changes in interest rates. If the rates decline, the values of bonds in their portfolio shoot up leading to capital gains for the investor.

INVEST IN SIPs THROUGH DEBT FUND:

Investors with a large sum to invest should opt for debt fund through the systematic investment plan (SIP) that allows an investor to invest in funds of their choice. Every month a fixed amount from the investor’s account is transferred to equity scheme.

For those nearing the retirement age should consider investing in a debt fund to enjoy a monthly gain. The monthly capital gain on the debt fund can be attained through the systematic withdrawal plan.

INVESTMENT TRANSPARENCY:

In a debt mutual fund, investors enjoy the facility of receiving the exact portfolio with respect to where the money is invested on a monthly basis with a minimum cost. This helps investors in evaluating the choice of investment with regards to the debt fund.

DIVIDENDS:

Debt mutual funds give the investors the liberty to choose the dividend, however these aren’t guaranteed.

EXIT LOAD:

Debts funds can be easily exited with the amount invested deposited in the investor’s bank account within a day or two of withdrawal. Please note that certain funds impose a penalty on investors for exiting the fund before the minimum period. The exit load can vary from 0.5% to 2%, while the minimum period can range from six months to up to two years. Verify the exit load of the fund before you invest. Even a 1% exit load can shave off a significant portion from your profits.

Still looking to invest in debt mutual funds? Don’t forget to read the terms and conditions carefully and make a smart choice with the information provided.