Though returns are market-linked, short-term debt funds are fairly
stable and best suited for goals that are 1-3 years away. They are also more
tax efficient than FDs.
Though bank deposits are the preferred in strument to save for
short-term goals, debt mutual funds can be a better alternative. They are more
tax efficient if held for more than three years and can even generate higher
returns for investors. You could be saving to buy a car, go on a foreign
holiday or even putting away money for your child's college admission. Meet
Bengalurubased Waman Prabhu (see picture), who is saving to buy a car in about
2-3 years. A short-term debt fund will give him greater flexibility and better
tax efficiency than bank deposits.
While Prabhu plans to start SIPs in a short-term debt fund, investors
can even put a lump sum amount in these funds. Jenny D'Souza has saved about `7
lakh for her daughter's foreign education. She might need the money in 16-18
months, maybe even longer.A short-term debt fund will give her the required
flexibility without tying her down to a fixed tenure.
Are debt funds safe?
It is a fallacy that debt funds cannot lose money. Their returns are
linked to interest rate movements.When rates fall, the value of the bonds held
by the mutual funds goes up, and vice versa. Interest rate cuts in the past six
months have led to a rally in long-term bonds. But short-term debt funds hold
bonds with a maturity of 1-2 years and are therefore not very sensitive to
interest rate movements. Their earnings are primarily from the accrual of
interest on the bonds they hold. Experts believe these funds will do well in
the coming months. “Even though we may see one or two more rate cuts, we expect
short-term bonds to outperform in the coming months,“ R.Sivakumar, Head of
Fixed Income at Axis Mutual Fund.
In fact, smart money has been flowing into this category for some years
now. “The AUM of short-term debt funds has shot up in the past one year. High
net worth investors are using short-term debt funds as a tax efficient
replacement of fixed deposit,“ reveals Kalpen Parekh, CEO, IDFC Mutual Fund.
Income funds, on the other hand, have a slightly longer maturity profile
of 4-5 years. These funds will do well if interest rates are cut further,
though experts are divided on whether the RBI will cut rates. If rates are not
cut, income funds will give tepid returns. Even so, they are likely to give
better post-tax returns in the 30% tax bracket. However, they may suffer some
hiccups in the near term because bond yields are close to 7% now. Historically,
long-term debt funds have not done too well when bond yields are so low. Go for
them only if you intend to remain invested for at least 4-5 years.
When investing in a debt fund, do note that there is a small exit load
(0.25-0.5%) payable if you withdraw before a minimum period. This minimum
period is usually 6-12 months but can extend to 1218 months in some cases. SIP
investors should note that each monthly instalment is treated as a separate
investment. Let's assume that a fund charges exit load if investments are
withdrawn before 6 months. If one starts a 12-month SIP in September 2016 and
withdraws the entire amount in September 2017, only the first six SIPs will
escape the exit load.
Sujit Waingankar
Member
P V Bhagwat Investment Guidance Cell
