This might come as a bit of a surprise, especially for debt fund investors. Just last month, the finance ministry abolished the long-term capital gains (LTCG) tax benefits, and indexation benefits.
Despite this, debt funds are still a good option to invest. And there are few reasons. Unlike the FD taxation where interest is taxed each year, the tax liability in debt funds arises only at redemption. So you can defer (capital gains) tax liabilities for years and allow more of your invested money to compound. If that is not enough, then you can also adjust capital losses from other investments against the capital gains from debt funds. Finally, good debt funds may still give better pre-tax returns than FDs if the fund manager is able to efficiently manage duration, credit and interest rate risk.
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While SIP has become a household term these days, it is mostly invested in equity funds. Debt funds are generally considered more for temporarily parking money or to make lump-sum investments.
For starters, what is SIP? It is just a way of investing systematically and periodically. It can be done in any type of fund, not just in equity funds.
SIP is not just for volatility
SIP, as an investment approach, is best suited for investing in assets/instruments, which are volatile and see lots of ups and downs. If you take the SIP route, it helps average out the volatility in your investment (entry) points and prices. That works well, given that you can completely avoid mistiming your entry prices.
So, if it works best for volatile assets, why SIP in debt funds? Debt funds aren’t exactly volatile, at least not like equity funds.
In general, net asset values (NAVs) of debt funds move in an upward trajectory, slowly and steadily. This is true for at least most of the debt funds whose portfolio has a shorter maturity profile. So, to be fair, if the NAV of such debt funds don’t fluctuate too much, the idea of SIP-averaging-to-counter-volatility doesn’t hold true here.
In such cases, obviously lumpsum investments are better than SIP. But most people don’t have lumpsum money available all the time. Hence for them, SIP might be a better option, if they are looking to accumulate funds for the short term (say a few years).
They can start a SIP in debt funds (like ultra short duration, money-market funds, low duration, and short-duration funds) then.
Related Reading – Having right expectations from debt funds
Which debt fund categories are suited for SIP?
All debt fund categories are not the same. Some are more volatile. So, while volatility is comparatively negligible in shorter-duration debt funds, it can be quite high in medium-long duration funds. Why? Because bond prices are sensitive to interest rate changes. And so are NAVs of debt funds holding those bonds.
Given the higher interest rate risk for longer-duration funds, the NAVs of debt funds that hold these bonds are a lot more sensitive to rate changes than those holding shorter-duration bonds in their portfolios.
If you have lumpsum available, doing SIP in categories like liquid funds, ultra-short duration, money market funds, etc. makes no sense at all. Just invest in lumpsum and be done with it.
For debt fund categories which are prone to interest rate risk, and hence, can be relatively volatile, doing SIP can be a better option than trying to time your lumpsum investment perfectly.
They include categories like gilt funds, gilts with constant maturity, medium-long duration, long-duration funds, etc. Also, some schemes in other fund categories like corporate bond funds, dynamic bond funds, etc., where average and Macaulay portfolio maturities (read more here) are on the higher side.
To give a one-line summary, if you plan to invest in debt funds that have a multi-year long duration or maturity profile, higher would be the volatility of such funds and you can consider doing SIP in them.
Debt fund SIP in asset-allocated goal portfolios
This is one use case when SIP in shorter-duration debt fund categories can be considered.
Suppose for a 10-year goal horizon, you want to invest Rs 50,000 monthly in an equity:debt asset ratio of 70:30. So, which debt fund categories can you pick to invest 30 percent in debt or Rs 15,000 monthly? You can choose 1-2 funds from categories like ultra-short/low/money market/short duration funds.
Related Reading – Debt funds suited for long-term goals
Or let’s say you want to set up an emergency fund and want to invest Rs 20,000 monthly for two years. Then, you can gradually do a debt fund SIP in liquid/ultra-short duration funds, if you don’t have lumpsum at hand.
To end, it goes without saying that when picking debt funds to invest in, irrespective of whether you go for SIP or lumpsum, always consider the risk appetite and your investment horizon, and then pick schemes from suitable debt fund categories with reasonably large AUMs and from AMC/managers with a good track record.
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