Debt funds score over bank RDs.
Often, people who like to invest systematically every month and build a debt portfolio invariably choose recurring deposits in banks. They feel happy that they know upfront what interest they will get throughout the investment period. No surprises.
If you start a bank RD when the interest rates are high, you will enjoy the benefit. But if you start when the interest is low, you will suffer throughout the term.
Such deposits are not tax efficient: Those in the 30 per cent tax bracket will lose 30 per cent and the surcharge on the interest earned. Let’s say the interest rate is 10 per cent. The effective return will be less than 7 per cent.
But if you want a tax-efficient opportunity in the fixed income space, and want to earn extra return, go in for systematic investment in fixed-income mutual funds.
How do the fixed-income mutual funds differ from recurring deposits?
Investment in fixed income mutual funds can generate higher returns than bank deposits mainly because they invest in a variety of debt instruments.
When the economy is doing well and inflation is low, the interest rate cycle will generally be low. That’s to boost the economy. This will impact the recurring deposit interest when you invest each time. But in mutual funds, such an interest rate swing will have less impact because of the nature of the instruments where the fund invests.
The biggest advantage with fixed-income funds is that they invest in a wide variety of instruments. This diversification is not possible with bank recurring deposits. Rather than investing in one type of investment, such as fixed deposit of particular bank or company, mutual funds invest in different types of fixed income instruments, such certificates of deposits, corporate deposits, government securities, non-convertible securities and pass-through securities.
Another attraction with mutual funds is that they are tax-efficient. If you stay invested for more than one year, the money you earn will be treated a long-term capital gain and taxed at 10.3 per cent—against the 30.9 per cent that bank recurring deposits charge top-slab investors.
Do such funds have liquidity issues? No. But you will be subject to exit loads if you withdraw before the stipulated time—each fund has its own rules that are told to you in advance. Income funds usually charge an exit load of 1 per cent if you withdraw before 180-365 days, depending on the scheme.
In the past 10 years, several debt funds have given a return of more than 9 per cent. For instance, if you had invested Rs 5,000 every month in Reliance Regular Savings fund for the past three years, your investment of Rs 1.8 lakh will today be worth Rs 2.07 lakh. That’s a yield of 9.4 per cent. Birla Dynamic Bond would have given you a return of 9.9 per cent.
If you feel that equities are risky, do invest in fixed-income mutual funds to build a debt portfolio.
If you want to construct a debt portfolio, write to info@myassetsconsilidation.com or suresh@myassetsconsoldiation.com.