Why I will still continue to invest in certain categories of Debt Funds

I will invest in Target Maturity Funds even after March 31 as I do not get this flexibility in Fixed Deposits (FDs). Here are my three simple reasons.

If I understand the main amendment in simple words, now all profits will be taxed as income and you will have to pay income tax. This is a big blow especially for debt investors.

There is talk that some categories of debt funds, especially the recently introduced and hugely successful target maturity funds, will no longer attract investors as they will move towards FDs. Some will be but I would still consider investing in them for these reasons:

Higher returns at lower yields

10-year government security yield data from 1998 shows that yields mostly move in a tight band of 5.5%-7.5%. In fact, more than 80% of the time, it’s between 7% – 8.5%. The price of a bond is inversely proportional to the yield. This means that if yields go down, bond prices go up and if yields go up, bond prices go down, which can also lead to capital loss.

We are of the view that the yield offered by Government securities is near its all-time high. So, if I take advantage of a higher loan yield and the yield falls, I can get a higher return than the expected regular return.

Yields have fallen from higher levels in the past as well and this happened in 2008, 2014 and 2019. The total return from debt funds was close to double the yield return.

tax deferment

Investing in target maturity funds whose maturity matches my retirement age or post-retirement age is a smart way to reduce tax impact. As per the current law, income tax has to be paid on the interest income earned from investments made in FDs.

Many of you will fall in the 30% tax bracket and this would mean less post-tax returns. The deferral of my tax points had more to do with my income levels. If I am 50 years old, and plan to retire at 58, where I will not have any income, I will invest in debt funds as the redemption will come in the form of income only after I retire, thereby Will help me reduce my tax liability. Here I pay taxes at much lower rates than what I paid during my prime working years, thereby earning higher post-tax returns.

Long Term

Many banks offer attractive FD rates only for a maximum tenure of five years. I have also seen the pattern where the longer the term of the deposit, the lower the rates. For example, the difference in rates between 1 year FD and 5 year FD is more than 25 basis points. A basis point is one hundredth of a percentage point.

In case of some target maturity funds, the holding period can be as high as 15 years. I think India’s interest rates are very high currently and hence I would like to lock it in for more years.

A final point that is applicable to all asset classes that have been forgotten about in the last 4-5 days is the fact that investors can deftly take advantage of the correction.

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

While it is imperative that short-term gains can be set off against short-term losses, both short- and long-term losses can be set-off for long-term gains. This can be a great reason for investors to invest in debt mutual funds if they incur some short-term losses or make up during the years of investment to adjust later. Losses can be carried forward for up to seven years. Therefore, the immediate concern about large withdrawals in debt mutual funds is just an overreaction. It’s a level playing field now, and that augurs well for the industry and targeted maturity funds in particular.

Anand K Rathi is the co-founder of Mira Money