Debt Funds Archives - Deeva Ventures Pvt Ltd

This wealth manager says even risk-takers must invest in debt funds. Here’s why

Known for his insightful investment nuggets on X (formerly Twitter), Kirtan Shah commands a substantial fan following on social media. As managing director of private wealth at Credence Family Office, which manages over Rs 10,000 crore in assets, he is associated with the wealth industry. But that’s not all.

As part of the education and training industry, he heads two ventures, FPA Edutech, a training provider of international certification programmes, and Ambition Learning Solutions, a leading player in the BFSI training industry, both of which he co-founded several years ago.

Shah, spoke to Moneycontrol’s Maulik M about how to design a simple portfolio and the importance of staying invested for the long term.

When the equity market is at a high, many investors say they want to wait to invest. What would you say to them?

This is a well-known fact and there are enough data studies to show that every time you invested at a market peak but stayed on for a longer time, your experience would have been the same had you invested at any other time.

Very specifically, if you’re a sophisticated investor, and you understand valuations are expensive, or you understand there is a strong resistance (technicals), and you want to wait, that’s a call you can take. But 99.9 percent of retail investors don’t really have the capability to judge this. If you are confident in the India story, and believe in at least 6-8 percent GDP growth roughly, plus a 4-6 percent inflation, I don’t see a reason why markets will not deliver about 12 percent CAGR (compound annual growth rate).

As a retail investor, you have only two things in your control. First, how much you save, and second, how long you stay invested. You can’t predict the return you will make or what (large-, mid- or small-cap, or value or growth style) will work in the markets in the next few years.

So play to your strengths, invest as much as you can and remain invested for as long as you can.

If someone has Rs 10 lakh today, where should they invest it?

First determine your risk profile and then, design an asset allocation strategy. So if you’re an aggressive investor, you would want more money in equities, if you’re conservative, you would want less. But both investors will still need other assets, too.

For example, if you are an aggressive investor, I would still suggest that you have 20 percent in fixed income and gold depending on what you read about the macros.

I am always asked why an aggressive investor must also have fixed-income investments. Even if I don’t talk about how that reduces risk without hampering returns, I would say, when the market falls, say, by 20 percent, most of us don’t have any additional money to invest. At such times, you can use this fixed income portion to buy markets at lower levels.

More specifically, I have a very simple formula.

In equity, you don’t need more than four or five schemes, irrespective of your investment amount, whether Rs 10 lakh or Rs 10 crore.

Split this equally between large-cap, mid-cap and small-cap funds, because you don’t know what will work in the next few years.

Make sure that your investment horizon is at least 8-10 years.

Also make sure that you have a good balance between fund houses that follow the value style and those that follow the growth style of investing.

Then, some part of your portfolio will definitely be performing irrespective of the cycle that you are in.

For fixed income (for an aggressive investor), you can put money in a medium-duration fund and a credit risk fund. Currently, we feel interest rates have topped out and that medium- and long-duration debt funds will do well for the next few months. But when rates are low (24 months from now), credit funds will start doing well. So that gives balance to your fixed income portfolio.

In equity, why not simply go for flexi-cap funds, instead of a mix of large-, mid- and small-cap funds?

In India, typically flexi-cap funds work like large-cap funds. On the other hand, when you invest around 33 percent each in a large-cap fund, mid-cap fund and small-cap fund, then the risk of this strategy is as good as a large cap fund (based on standard deviation) and your returns are as good as for mid-cap funds. On a risk-adjusted basis, it’s better than investing in flexi-cap funds, with your eyes shut. There are hardly two or three flexi-cap funds that are genuinely flexi-cap.

What do you think of gold as an investment? And what about investing in it today?

For me, gold is a tactical bet. I hear a lot of us saying that we should have gold. But what is going to significantly change in your portfolio with a 5-10 percent allocation to gold? Nothing.

If you look at the last 12 years, gold’s dollar return has been 0 percent, and the rupee return has been 3.5 percent, and that’s only because the rupee has depreciated. So, what problem is gold really solving in your portfolio? To me, it is an extremely tactical bet.

Is that bet going to work, today? I think, yes.

Gold works very differently in terms of dollars and in terms of rupee. First, gold in dollar terms—whenever the dollar depreciates, gold will go up because then people buy more gold. Are we expecting the dollar to devalue? The answer is yes, because we think interest rates globally have topped out and when rates start falling, you will see the dollar depreciate. So in terms of dollar denomination, we think gold will do well.

But I’m not sure how well it will do in rupee terms. India is expected to be a far stronger emerging market (EM) currency versus others in the EM space. So if the dollar were to depreciate, the rupee would go up. This will be counterproductive for gold returns in rupee terms.

So your bet depends on both these factors, and they are both at pivoting points right now. So a retail investor should not take this bet.

Do debt funds still make sense after the loss of indexation benefits in 2023?

As a retail investor, I have multiple other options. I can go for corporate deposits and fixed deposits in small finance banks. Now, we can argue that interest rates are going to fall and so long-duration funds will do very well (give capital gains). But that is not written anywhere. So these funds are not meant for retail investors.

But for a sophisticated investor, I think long-duration funds are still the most appropriate option, provided you understand the interest rate cycles. Making around 8-8.5 percent is no problem at all if you can give it two to three years and understand the cycles. Debt funds give many advantages to a sophisticated investor—ease of liquidity, multiple categories to choose from depending on risk capacity, and scope for diversification. So, such investors should still stick to debt mutual funds.

What are some of the biggest investment mistakes to avoid?

Looking at the last three years’ returns and investing in the market.

Investing based on some data points given on media or social media.

Diversification does not mean having 20 funds. Many investors keep adding newer funds in the name of diversification.

Lack of discipline. Most equity fund SIPs (systematic investment plans) close in two years’ time.

Source- Moneycontrol

Why I will still continue to invest in certain categories of debt funds

The Finance Bill, 2023, with 64 official amendments, was approved by the Lok Sabha without discussion on 24 March. The key amendment that will affect all fixed income investors is about debt mutual funds. These funds have been stripped of the long-term tax benefit if they invest less than 35% of their assets in equities. Such mutual funds will attract short-term capital gains tax.

I would still invest in target maturity funds even after 31 March because fixed deposits (FDs) don’t give me these flexibilities. Here are my three simple reasons.

If I were to decipher the key amendment in simple words, all the gains will now be taxed as income and you will have to pay income tax. This is a big jolt, especially for debt investors.

There is a chatter that a few categories of debt funds, especially the recently introduced and hugely successful target maturity funds, will not attract investors now as they will move to FDs. Few will but I will still look at investing in them for these reasons:

Higher returns if yields come down

The data on 10 years government security yield from 1998 points out that yield mostly moves in a tight band of 5.5%-7.5%. In fact, over 80% of the time, it’s between 7%- 8.5%. The bond price is inversely co-related to yields. This means if the yields go down, the bond prices go up and if the yields go up, then bond prices go down potentially leading to capital losses too.

Our view is the yields offered by government securities are near their high. So, if I capitalize on higher debt yields and the yields fall, I can make higher returns than just the expected regular yields.

The yields have fallen from high before too and happened in 2008, 2014, and 2019. The total returns from debt funds were close to double the returns of the yield.

Deferral of tax

Investing in target maturity funds that have maturities matching my retirement age or post-retirement age is a smart way of reducing the tax impact. As per the current law, one must pay income tax on accrued interest income out of the investments made in FDs.

Many of you will fall in the 30% tax bracket and this would mean low post-tax returns. My deferral of tax point was more to do with my income levels. If I am, let’s say 50, and plan to retire at 58, where I would have no income, I would invest in debt funds as the redemption will come to me as an income only after I retire thereby helping me reduce my tax liability. Here I pay taxes at much lower rates than what I would have paid during my prime working years leading to higher post-tax yields.

Longer duration

Many banks offer attractive FDs rates only for a maximum period of five years. I also have seen the pattern where the longer the duration of deposits, the lower the rates. For example, the difference in rates between a 1-year FD and a 5-year FD is over 25 basis points. One basis point is one-hundredth of a percentage point.

In the case of a few target maturity funds, the holding duration can go up to 15 years holding too. I think India’s interest rates currently are high enough and hence I would like to lock it in for longer years.

The final point which is applicable to all asset classes that have been forgotten in the last 4-5 days is the fact that the investors can smartly avail the benefits of setting off.

Set off is an option where investors can use the benefits of any losses that they carry to be adjusted against the gains made during the same or different financial year.

While it is mandatory that short-term gains can be set off against short-term losses, for long-term gains both short- and long-term losses can be set off. This can be a big reason for investors to invest in debt mutual funds if they carry some short-term losses or create during the years of investment to adjust later. The losses can be carried forward for seven years. So, the immediate worry of debt mutual funds seeing huge outflows is just a mere exaggeration. Now it’s a level playing field, and this augurs well for the industry and especially target maturity funds.

Source: Livemint

What are debt mutual funds?

Debt funds are a type of mutual funds that invest in fixed income-generating securities such as treasury bills (short-term debt instruments issued by the Government of India), government bonds, corporate bonds, other money market instruments, etc.

What are bonds, you might wonder? Let’s start with the basics. Just like you go to a bank for a loan, governments and companies can borrow money from the financial market (think institutional investors and people like you and me). When they take the loan from the market, they issue a certificate of deposit called bonds.

And just like you need to pay an EMI to repay your bank loan, governments and companies pay an interest on the loan they have taken from the financial market. These instruments have a fixed maturity date and help you earn an interest till maturity.

Why do people invest in debt mutual funds?
We know that for wealth creation, equity funds are the most suitable investment. In fact, you can check the best equity mutual funds handpicked by our research team. However, they are not an ideal short-term investment option. By short-term, we mean one to three years.

So, where do you invest your money to meet your near-term goals? Enter debt mutual funds (debt funds in short).

Debt funds invest in fixed-income instruments, such as bonds. As explained earlier, investing in fixed-income securities is like giving out a loan and receiving a fixed interest on it. The interest you earn can be paid monthly, quarterly, semi-annually or annually. Because of this, debt funds are pretty stable compared to equity funds.

Another reason for people to invest in debt funds is diversification. Investing in them helps balance out the risk. Let’s say you want to invest Rs 5 lakh. Putting all your money in equity funds can be risky. In order to reduce the risk, some portion of the money can be put in the relatively-safer debt funds.

The third reason is convenience. While you can directly invest in corporate bonds and government securities, it is a hassle. Also, there are several instruments that are not available to individual investors. Hence, it is much easier to invest through debt funds. They have the access to buy different types of fixed income securities. What’s more, you can start investing in debt funds with just Rs 500 to Rs 1,000.

What else should you know before investing in debt funds?

• Liquidity: You can exit your investment whenever you want and receive the money in two to three days’ time. And unlike traditional avenues, debt funds don’t have a lock-in period or a tedious withdrawal process.

• Steady, yet moderate, returns: As debt funds invest in fixed-income securities, their returns are stable. However, since they are less risky, they yield a lower return than equity-oriented mutual funds.

• Risks involved: Debt funds are not completely risk-free. Rise in the interest rate and credit default can be bad news for debt funds. Let’s understand these one by one.

Let’s say the interest rates are going up or there is an expectation of the rates going up. When this happens, the newly-issued bonds start offering higher interest rates. As a result, the demand for existing bonds – those that might be a part of your debt fund – falls. And with it falls the price of the existing bonds and the value of the debt fund.

The other kind of risk is credit risk. If any underlying bond issuer defaults and fails to honour the payments, it will affect the portfolio value of the debt fund. Hence, diversification is important in debt investments too.

Tax efficient: Unlike fixed deposits, where the accrued interest is taxed every year, mutual fund gains are taxable only when they are realised, i.e., at the time of selling the debt fund investment.

For example, if you invest in an FD and earn Rs 5,000 interest every year, this amount is added to your taxable income for that year even if you do not realise the interest. However, in case of debt funds, if the value of your investment increases by Rs 15,000 by the end of the first year and you remain invested, you don’t have to pay any tax. Only when you redeem your mutual investment are you required to pay tax.

Better returns compared to its peers: These funds have the ability to generate reasonably better returns than a savings bank account and even bank fixed deposits, especially after you calculate the tax. Hence, they are ideal for investors who are risk-averse and looking for short-term investments.

Source: Valueresearchonline

Why Debt Funds are Better Than Fixed Deposits

Fixed Deposits (FDs) have been the go-to investment option in India for many generations. This popularity is mostly due to the guaranteed returns and the low risk associated with FD investments. So deep is the love for FDs that they are used for every goal – be it short-term or long-term. And while FDs can be a good option for short-term investments, there is a smarter way to invest in Debt for the long term. The solution is Debt Funds.

While Debt Funds might not offer guaranteed returns, they do outscore FDs on one of the most crucial factors – taxation.

In this blog, we will discuss how debt mutual funds are better than fixed deposits in terms of return, risk, liquidity, dividends, etc. And how FD interest earnings and Debt Fund returns are taxed.

Taxation Rules of Fixed Deposits Vs Debt Mutual Funds
Although Fixed Deposits and Debt Mutual Funds are debt instruments, there are quite a few differences in how they are taxed. The first and perhaps the most fundamental difference is when the returns are taxed.

In the case of Fixed Deposits, the entire interest earned is subject to tax for the applicable financial year. In fact, all the interest earned from FDs in a financial year has to be declared in your Income Tax Return under the head “Income from Other Sources”. On the other hand, Debt Fund returns are taxed only when they are realized, i.e., when the investments are redeemed. This is called deferred tax treatment.

Apart from this fundamental difference, for the holding periods of less than 3 years, there is no difference between how FD and Debt Fund taxation works. The returns are added to your income, and you are taxed as per your Income Tax Slab rate.

However, for the holding period of more than 3 years, while FD taxation remains the same, the Debt Funds taxation rules change. That is because Debt Fund gains are classified as Capital Gains and the rules for Capital Gains are different for different holding periods.

If you redeem your Debt Fund investments after holding them for at least 3 years, the gains made are classified as Long-Term Capital Gains or LTCG. As per current rules, LTCG are taxed at 20% after indexation.

There are two words here – 20% and indexation. And these two things along with deferred tax treatment make Debt Funds far more tax-efficient than FDs. While the 20% rate is fairly clear to understand, indexation is a bit complicated. However, it is perhaps the bigger reason for the tax efficiency of debt funds. So, let’s look at it a bit deeper.

Difference Between FD and Debt Mutual
Fixed deposit is an instrument wherein you invest an amount with financial institutions like banks and NBFCs for a fixed period. In return, you receive interest. You can invest in the fixed deposit for a minimum of 7 days and a maximum of up to 10 years.

Debt mutual funds are a type of mutual fund managed by an Asset Management Company (AMC). When you invest in debt funds, your money is invested in debt papers of private companies, PSUs, government bonds, etc. In the case of debt mutual funds, you are not promised a certain amount on maturity. In fact, for most debt funds, there are no maturity dates. You can enter and exit at any time. And well-managed debt funds have typically delivered better returns than FDs.

How Indexation Helps Reduce Tax Liability of Debt Funds
Indexation is the process using which you adjust the purchase price of an asset to account for the increase in inflation between the time you bought the asset and sold it. In case you are confused, don’t worry, we will try to simplify the concept with an example.

Suppose you bought a Spiderman comic book 5 years back for Rs. 500, but you had forgotten all about it. Recently you were going through some old things, and you found the old issue still in its original packaging which had never been opened. After a quick online search, you find that a new edition of the same comic would cost you Rs. 1500.

But since the comic book you have is older, and in mint condition, some collectors are willing to pay Rs. 2500 for your comic book. So, if you were to sell it, your profit will be = 2500 (your selling price) – 500 (your purchase price) = Rs. 2000.

But, due to inflation, the current market price of the comic book has increased to Rs. 1500. So, for the purpose of taxation, the government allows you to adjust the purchase price of your comic book to account for inflation. So, your taxable profit from the sale of your comic book will be = 2500 (your selling price) – 1500 (current purchase price) = Rs. 1000.

While indexation calculations of Debt Fund Investment returns are much more complicated than the simple example provided above, it gives you an idea.

Bottom Line
As a tool to preserve wealth, the fixed deposit makes perfect sense considering the key benefits of guaranteed returns and minimal risk.

However, if you are planning to book an FD for tenures exceeding 3 years, it might be a good idea to rethink your strategy and invest in Debt Mutual Funds instead. At the very least, such long-term Debt investments will significantly reduce your tax liability especially if you are in the highest 30% tax bracket. At best you will earn higher returns on your investment than what an FD can offer while still ensuring that you pay less tax on your investment returns.

Source: Etmoney

7 ways you can avoid getting into a Fatal Traps of debt fund

Rather than parking your surplus money in a bank account or fixed deposit, Park them in a Debt fund for benefits like higher returns, regular income, high liquidity, low risks, reasonably predictable returns, and the benefit of Indexation.

Debt funds are definitely great investment vehicles if you select them smartly based on your investment objective and risk appetite.

1) Liquidity: Look for the exit option of the fund and avoid close-ended funds. No liquidity when in need of funds can be a pain for your investment portfolio.

2) Investment Horizon: Don’t choose a fund simply because it is offering great returns. It is really important to figure out your investment horizon and then choose a fund with a matching profile. Parking for Long-Term in Liquid fund is not a good idea.

3)Taxation: Debt Mutual Fund comes with indexation benefit when redeemed after 3 years and taxed as per your slab if redeemed before 3 years.

4) Credit Rating: Some schemes may bet on lower-rated papers to generate better returns, but it comes with the risk of losing money. So, if you are a conservative investor, you should opt for high rated papers and invest in lower-rated papers to generate extra income.

5) Interest Rate Movement: Change in interest rates has a big impact on debt schemes. Rising interest rate is bad news for most debt funds whereas A falling rate scenario is a treat. This is because of the inverse relationship between yields and prices of bonds.

6) Brand: Invest with reputed Indian brands such as ICICI, Kotak, IDFC, HDFC, SBI Etc. Avoid new & small fund houses. Why put your hard-earned money in lower brands for mild gain.

7) Fund Size: Large funds can distribute fixed expenses over a number of investors bringing down the expense ratio. Large funds can also negotiate better rates with issuers of debt.

Emergency Funds – Why have it, How to Build & where to Invest.

An emergency fund is an essential corpus that you must keep aside to tackle emergencies.

It is a fund that you can fall back on at the hour of crisis or for unexpected and unplanned scenarios in Business as well as your Personal life.

1. How to Build an Emergency Fund? An emergency fund cannot be built overnight but is done gradually.

Set aside a particular amount every month. Soon it will grow into a considerable corpus that you wish to have.

2. How much should your Emergency Fund have? Depending on your income and expenses, an emergency fund can be three to six months of your monthly expenses.

3. Where to Invest in an Emergency Fund? The emergency fund should be parked monthly to a Liquid Fund with no exit load. Don’t forget to put a small portion in a bank account that is available 24/7.

The economic crisis is a vivid example of why an emergency fund can be so important. If you don’t yet have an emergency fund, now is the time to prioritize it.

Here is a 7 Step Guide to avoid Fatal Traps in Debt Funds.