It has been a year since debt funds are in troubled waters. The crisis that started in September 2018, following the IL&FS fiasco has only compounded with time
It has been a year since debt funds are in troubled waters. The crisis that started in September 2018, following the IL&FS fiasco has only compounded with time.
It spread to entities such as DHFL, Essel Group and Yes Bank, among others. Debt funds recorded outflows worth Rs 1.25 lakh crore in 2018-19, compared to Rs 9,128 crore in 2017-18.
In such testing times, the question arises -- should you ignore them altogether? Let us find out.
Debt funds play an essential role in asset allocation
While the ongoing crisis in debt funds may prompt you to shun them altogether, the move is not prudent. This is because these funds play a crucial role in asset allocation.
We must note that sound investment strategies do not revolve around a single asset, but hinge on diversification. Debt funds provide the much-needed diversification that your portfolio warrants.
Having said that, in these times, when the debt funds are facing the heat, it is essential to tread with caution. Before investing in a debt fund, look out the sectors and companies where the fund invests.
High concentration in a particular sector should be a red flag. Opt for a fund which invests across the sector with sound fundamentals, and has the potential to deliver better returns than fixed deposits.
Amid all the turbulence, debt funds have the potential to deliver better returns than bank fixed deposits (FDs).
Note that, with the Reserve Bank of India (RBI) cutting repo rate by 35 bps in August (the rate at which it lends to banks), many lenders have already started cutting interest rates offered on FDs.
In such a scenario, ultra-short-term funds, which invest in fixed earning instruments with a maturity period of six months, can help you to make some gains.
The one-year average return of ultra-short-term fund has been 6.14 percent, which is still high compared to FDs offered by most commercial banks.
Better tax treatment:
This is another significant benefit of investing in debt funds. They can lower your tax liability. This is because long-term capital gains from debt funds are taxed at 20 percent with indexation benefit.
It means, if you hold onto your debt funds for more than 36 months, or 3 years, the profits made qualifies for long-term capital gains and get indexation benefit.
Indexation factors in inflation during the holding period raise the acquisition cost accordingly. This, in turn, lowers the gains made and subsequently helps in tax saving.
Ideal for setting up an emergency corpus:
Emergencies often arrive unannounced and can derail even the soundest of financial plans. Thus, it is important to be guarded against them and build a corpus for the same. Debt funds help you do that with ease.
You can set up an emergency corpus by parking money in liquid funds, which you can invest in market securities with a maturity period of up to 91 days.
They have the potential to deliver better returns than a bank savings account and can be easily accessed when required. Additionally, recent norms on these funds by market regulator Securities and Exchange Board of India (SEBI) have made them more liquid.
As per SEBI’s latest norms, liquid funds need to hold at least 20 percent of their assets in cash or cash equivalents to ensure sufficient liquidity always.Also, the one-year average return from these funds stands at 6.85 percent much higher than what’s offered by a bank savings account.
A word of caution:
While the above reasons are strong enough not to ignore debt funds completely, it is equally essential to remain cautious about investing in them. Prior to investing, make sure the fund does not have exposure to low-rated securities.
At the same time, go through the fund fundamentals and see its returns across market cycles for a period of five-six years. Additionally, do not get bogged down by poor returns in the first few years of investment.
If you have chosen a fund with sound fundamentals, you will definitely reap rewards in the long run. Also, instead of investing a lump sum, opt for a systematic investment plan (SIP) which neutralises market extremes and helps you to remain invested across cycles.
Bringing a discipline into your investment, SIPs help you achieve your goals in a sustained manner.
(The author is Head, Personal Wealth Advisory, Edelweiss)Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.The Great Diwali Discount!
Unlock 75% more savings this festive season. Get Moneycontrol Pro for a year for Rs 289 only.
Coupon code: DIWALI. Offer valid till 10th November, 2019 .