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

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.