When it comes to mutual fund investments, two popular choices for investors are equity and debt. Equity mutual funds offer high returns to investors over the long term. But what about debt mutual funds; what can they offer investors? Let’s find out.
- Regular income
Debt mutual funds are ideal if you are looking for an investment avenue that generates regular income. You can opt for a Systematic Withdrawal Plan (SWP) that provides you with regular tax-efficient income at regular intervals when you invest a corpus. This is how an SWP works: You invest a lump sum in a debt mutual fund and fix an amount that you wish to withdraw each month. This provides you with regular cash flows while the balance amount continues to remain invested.
- Tax efficiency
Debt funds are more tax efficient than traditional investment options. For instance, the interest income you earn on fixed deposits is taxed each year based on your eligibility and income slab. However, in the case of debt mutual funds, you have to pay Short Term Capital Gains (SCTG) tax only if you hold your fund units for less than three years. After that, you can take advantage of Long Term Capital Gains (LTCG) tax of 20% post indexation. This method can help consider inflation for the period when funds are purchased and sold. It can help reduce your tax outgo significantly.
Saving accounts such as fixed deposits have a specified lock-in period. If you liquidate your FD prematurely, you could be penalised. Debt mutual funds do not have lock-in periods. You can withdraw your investment any time you wish. For example, in the event of a financial emergency, you can withdraw your capital from debt funds immediately. This gives you greater flexibility to use your capital when needed.
Debt funds are an essential component of any portfolio due to its stability and regular income. Equity funds can be volatile as their returns are linked to the stock market. By investing a portion of your money in debt funds, you can adequately diversify your portfolio and reduce overall risk.
When you invest in a Public Provident Fund (PPF), you have to stay invested for a period of 15 years. Similarly, you cannot break your FDs (without incurring a penalty) until the lock-in period ends. But when you invest through debt funds, you can shift your funds based on your requirements. For instance, a large corpus of money in a savings account may not be an ideal investment solution because of its minimal returns of 3.5% per annum. At the same time, you are unsure of investing it in equities.
Instead, you can invest the lump sum amount in debt funds and start a Systematic Transfer Plan (STP). This allows you to transfer a fixed amount of money systematically from your debt fund to equity funds. This way, you can benefit from rupee cost averaging and earn higher returns than a savings account.
If you are looking for a regular stable income and limited exposure to market risk, debt mutual funds can be an ideal choice. You can choose among different debt funds such as liquid funds, ultra-short term debt funds and fixed maturity plans to invest based on your investment goals and time horizon.