I have put money in Bank FDs in the last few months as the rates offered were quite attractive. Now with the FD rates coming down, I wish to explore MFs and want to invest in debt instruments for medium- to long-term (over five years). Since there are a number of different types of debt funds available viz. Gilt funds, MIP, FMP, liquid funds, short or medium or long term debt funds, which one of these will you recommend for me.
Will these investments provide a better post-tax return than a bank FD with negligible credit risks? Is there a merit to opting for SIPs in debt funds rather than lump sum investments? Are there entry loads for these funds and will investing directly without agent help save this?
-Ankur
For a time horizon of around five years, you can consider investing in a medium term debt fund. A well-rated income fund with a good track record can be chosen.
Debt funds (long-term) offer higher tax efficiency and liquidity as compared to fixed deposits. The interest earned from a bank FD is added to one’s income for tax purposes which is taxed as per the applicable slab of the investor. On the other hand, returns earned from a debt fund held for the long term i.e. greater than one year are treated as long term capital gains (LTCG). One can avail the indexation benefit in case of LTCG of debt funds which reduces the tax liability. LTCG is then taxed at 11.33 per cent without indexation or 22.66 per cent with indexation.
However, debt funds are not risk-free like bank fixed deposits. They invest in bonds and hence, carry credit risk and liquidity risk related to the specific instruments held by them. They are also affected by interest rate risk. Hence, the choice of whether to invest in a bank fixed deposit or a debt fund would depend on one’s risk appetite.
SIP is a suitable method of investing in equity funds because equity, as an asset class, is more volatile. For debt, one-time investment is recommended. As for saving entry load, direct investments without an intermediary are not charged entry load. But at the same time, normally, debt funds do not charge an entry load.
This article was originally published on February 13, 2009.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
