Debt Funds – an amazing and Unknown product!

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“It doesn’t matter if you’re black or white… the only colour that really matters is green.” – Family Guy

Aptly said. Money is the most secular thing, a man has ever made. The person, who knows how to use the money, wins the race. Money doesn’t check your degree or religion. It belongs to those who use intelligence to grow money.

The question raised by a client of mine is if the market is so volatile, it is always wise to invest in equities. I admit it is wise, but one should not forget about what Warren Buffett said – do not lay all your eggs in just one basket. If someone asks you what is more important – proteins or carbs? Both are important, to the extent of one’s health. In the same manner, all types of investment options are important and essential, depending on the risk appetite of that investor.

We all know about equity-based mutual funds. But how many of us know about Debt Mutual Funds – very few! As per me, it is a wonderful product and can be used for any requirement of an investor. It is for everyone.

Let me inform few good points about debt funds:

  1. Full liquidity
  2. Exit Load – only for few funds and that too for few months only
  3. No TDS Deduction on profit
  4. Inflation-linked Taxation Liability
  5. No lock-in period
  6. Investments are done in Bank FD, Company Debentures and Govt. Bonds
  7. No equity exposure makes it a safe option

Let us understand a very good example of how debt funds can be useful. X has a car loan for 7 years at a 9.5% interest rate. EMI is Rs. 12,500 per month. Now, this person has somehow saved Rs. 1.50 lakh in December, which is the exact amount of the EMI for the whole year. He invests in a Debt Fund and gives a standing instruction that Rs. 12,500 should be withdrawn in the month-end for the next 12 months. This withdrawal has started in December. On checking about profits, X found out that he has earned approx. 7.5% returns on it.

Hence, in this example, his net expense on interest is just 2% (9.5% interest minus 7.5% returns). On the other hand, if he had kept it in a savings account, he would have earned just 4% and his expense would be approx. 5.5%.

Interesting!!

Let us understand the taxation aspect of the income on Debt Funds:

Particulars Investor @ 30% Tax Bracket Investor @ 20% Tax Bracket Investor @ 5% Tax Bracket All category of investors STCG @ flat 15%
Amount Invested 1,00,000 1,00,000 1,00,000 1,00,000
Interest Rate @10% 10.00% 10.00% 10.00% 10.00%
Tenure (year) 3
years
3
years
3
years
3
years
Maturity Value (Rs.) 1,33,100 1,33,100 1,33,100 1,33,100
Gain (Rs.) 33,100 33,100 33,100 33,100
Cost after Indexation 1,09,470
Tax on Long term Capital Gains 31.20% 20.80% 5.20% 20.80% capital gain
Tax (Rs.) 10,327 6,885 1,721 4,915
Post Tax Maturity Value (Rs.) 1,22,773 1,26,215 1,31,379 1,28,185

So, even if you fall under the highest slab, you are earning a bit less than the lowest tax slab.

The best ways to use Debt Funds are:

  • Use it as an alternate to Bank Savings Account
  • Use it to park excess money from your Current Account
  • Use it to earn some better returns for the money you need after a few weeks/months
  • Use it to earn more than Bank FD / NSC / KVP / Post Office Savings Account, again with a full liquidity option
  • Use it to leverage your interest rate on any small loan
  • Use it to safeguard your loss when the share market is falling

Inform any more creative use of Debt Funds in the comments to this blog. Share the link of this blog with all those who require aid in falling markets.

American Actor Will Smith says
– “Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like.” Earn more, because you can!!

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