Hello,
A key step of managing your investment portfolio is diversification. We all have Fixed Deposit investments (thanks to our parents influence) and many of us have an exposure to equity mutual funds. What is often ignored is investment into debt funds.
What is a debt fund?
A debt fund is an investment pool, which may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt. Simply put, it means that they lend money and earn interest. The interest they earn forms the basis for the returns they generate for investors. Click here to read a more detailed article on debt funds.
What is a debt fund?
A debt fund is an investment pool, which may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt. Simply put, it means that they lend money and earn interest. The interest they earn forms the basis for the returns they generate for investors. Click here to read a more detailed article on debt funds.
The advantages of investing in an open ended debt fund are
- Ideal for a conservative investor
- Adds stability to investment portfolio, not affected by equity market volatility
- Far more tax efficient than fixed deposits in the long term, due to indexation benefit for funds held longer than 36 months
- No TDS in debt funds for resident individuals / HUFs / domestic corporates, (there is a dividend distribution tax if you choose dividend payout option).
- Allows you to redeem your units at any time
This illustration will explain how debt funds are tax efficient
Amount invested in October 2018 (FY 2018-19) and redeemed in April 2022 (FY 2022-23) the investor is eligible to take four indexation benefits over 5 financial years viz. 2018-19, 2019-20, 2020-21, 2021-22, and 2022-23.
| Particulars | Fixed Cost | Taxation on debt fund (with indexation) | ||
| Amt Invested in Rs | Rs 1.00 lakhs | Rs 1.00 lakhs | ||
| Assumed Annualised Rate of Interest | 7% | 9% | 7% | 9% |
| Gross Value at Maturity | 1,26,309 | 1,34,648 | 1,26,309 | 1,34,648 |
| Indexed cost of acquisition | NA | NA | 1,16,986 | 1,16,986 |
| Capital Gains / Interest on investments | 26,309 | 34,648 | 9,323 | 17,662 |
| Applicable tax rate | 35.88% | 35.88% | 23.92% | 23.92% |
| Taxable Income | 26,309 | 34,648 | 9,323 | 17,662 |
| Tax Liability | 9,440 | 12,432 | 2,230 | 4,225 |
| Post tax value at Maturity | 1,16,869 | 1,22,216 | 1,24,079 | 1,30,423 |
| Post Tax Gain | 16,869 | 22,216 | 24,079 | 30,423 |
| Post Tax Gain CAGR | 4.62% | 5.98% | 6.45% | 8.00% |
- Indexed Cost of acquisition is computed assuming an inflation rate of 4% p.a.
- Tax rate assumed is highest rate based on the current tax slabs for Individuals/HUFs with income above Rs. 1 crore. For domestic corporates, corresponding tax rate applicable would be 34.94% for interest on term deposits and 23.30% for long term capital gain on FMP investments.
Personal Investment
I have personally invested in a debt fund called Franklin India Low Duration Fund. What made it attractive is the historical performance of 8.69% 3 year return and 9.05% 5 year return. The average maturity of the portfolio is 1.03 years (generally shorter the maturity, greater the funds stability. The portfolio consists of high rated papers. For details, you can click here
Phew! I know it's been a long mail but I hope it gave a fair and easy understanding of debt funds. Please feel free to reach out for any clarification or queries at mathewpravin@yahoo.com / 9900335853.
Regards,
Pravin
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