Debt funds are an area that most retail investors are
not familiar with. But investing in debt
mutual fund schemes have benefits, that other
products in the debt space may not be able to offer.
It is important to consider aspects like liquidity,
tenure, post-tax returns, risk associated with the product, amount to be
invested and others before putting together the debt portion of the portfolio.
Bank & company FDs, PPF, small
savings instruments etc. are normally the tools of choice for most investors.
They use these as these options have existed for long and are easy to
understand. All these instruments give fixed returns, which is a source of
comfort. What they would be missing out is in terms of liquidity, taxation
& rigidity in tenure.
As financial planners, we find tremendous value in
debt Mutual funds to tailor solutions to meet the needs of our clients.
Longterm
investment needs : Longterm corpus building is an important part
of the planning process. This corpus is to take care of retirement as well as
other longterm goals like Children’s education, marriage, retirement home among
others. As part of the asset allocation some portion will be in debt
instruments. Medium to longterm debt funds, including bond and gilt funds are
good candidates, which have the potential to offer between 8-9% longterm.
Currently, income funds are offering double digit returns, which may continue
for some more time. The attraction here is that the tax treatment is benign,
for investments over one year. Long term capital gains tax applies here, where
indexation benefit can be taken advantage of. After this indexation, the actual
tax incidence may be in the region of 4-6% ( assuming current levels of
inflation ). Hence, there is little difference between gross and net returns as
opposed to most other instruments where the gross returns would match a debt
fund return, but the net returns don’t.
Liquidity
& other shortterm needs : Liquidity provisioning is to take care of
sudden surges in expenses, which are not anticipated. By it’s very nature,
these funds have to be available, at short notice. At the same time, the money should
be deployed in a manner that it earns good returns. That is why liquid funds
are a good option. Dividend Distribution option was the best option for this
purpose. But, now things have changed after the current budget and the dividend
distribution tax is at 28.3%. This tax is paid by the Mutual fund houses and
hence indirectly the investor is paying for it. For a person in the highest tax
bracket, this is definitely recommended. For those in the lower tax brackets,
growth option would be a better choice, as the taxation is on their marginal
tax rates, which is lower.
One more thing needs to be kept in mind. There are
some who are far more prudent in managing their finances, than others. In such
cases, we find that they do not access the liquidity margin for very long
periods, stretching to years. In such
cases, Growth option can straight away be suggested, as beyond one year, one
can apply indexation and the taxation incidence reduces.
The other thing that such investors could consider is
shortterm or even medium term funds. These funds may have an exit load for a
certain period. But, since these clients are disciplined, the chances of them
cashing out in the initial exit load period is limited. Hence, these investors
could enjoy potentially higher returns, even on the liquidity margin.
Contingency
planning : Contingency
funds are created to take care of specific expenses that are anticipated, but
their frequency or timing is not known. An example of this is a contingency
fund for one’s parents. In this situation, it would be a better idea to invest
in medium to longterm funds or in actively managed debt funds in the growth
option, as the requirement may not be immediate. This way these funds can earn
a higher return as compared to Ultra Short-term funds or Short-term funds.
Planning
for upcoming goals/ payments in the near term : Here, the goals or payments may be in the
near term like three months to six months. It may be required for school fee
payment In the next six months or to fund holiday expenses in the next six
months or other such requirements. In this situation, an Ultra Short-term fund
may be a good option. However, if the provision comes beyond six months the
provisioning can be done through a Short term fund. Even a medium term fund can
be considered if the tenure is beyond a year.
One can also consider Monthly / Quarterly Interval Plans for
requirements whose time of need is fixed. But, in these cases, one needs to
cash out in the window period available.
Investments
& planning for upcoming goals : Fixed Maturity Plans are a good option for
those who want fairly stable returns, without market fluctuations and who
strive for tax efficient returns as typically indexation benefit is sought in
an FMP. Hence, this can be a good instrument for investment purposes. FMP
investments are usually beyond one year duration, due to which single, double
or triple indexation benefit can be availed of, as applicable and I hence tax
efficient. FMPs can also be used for provisioning or meeting short term goals
as it matures after a tenure and directly comes into one’s bank account.
As we have discussed, debt funds can be used in one’s
portfolio for a whole range of planning and can be the backbone of financial
planning. As investors, one needs to understand and appreciate their place in
the portfolio and the value they add in a planning exercise. It is not as
arcane as it first sounds, does it?
Article
by Suresh Sadagopan Published in Business Standard
For
Comprehensive Financial Planning come to the experts - Ladder7 Financial
Advisories
No comments:
Post a Comment