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Excess funds in bank? Pick a debt fund

Demonetisation has led to increased bank deposits but instead of keeping the money in the account, you can consider debt mutual funds

The move to demonetise old Rs500 and Rs1,000 currency notes, among other things, will certainly ensure that idle cash gets into bank accounts. Now that it is in a bank account why leave it idle? Find an appropriate way to invest it and earn a return, which beats the 4% average that most bank savings accounts offer.

Fixed deposits are an option, but don't go for them till you have explored what is available in the debt fund universe. Debt funds are of varying types and it is not too difficult to find one that suits your risk-return requirements.

For your liquidity needs
As per the Reserve Bank of India (RBI) data, banks have over Rs100 trillion of deposits. Compared to this, debt mutual funds have only Rs10trillion in assets under management (AUM). While familiarity and assured returns may draw people to fixed deposits, they are beaten by mutual funds in terms of returns. Also, in some cases, debt mutual funds are more tax efficient.

The money you invest in fixed income schemes should be that portion of your asset allocation which you would need in the next few months to a couple of years. Therefore, you would like to keep it accessible and would not want to risk the capital. Debt funds can be a good choice in such scenarios. These are mutual fund schemes that invests money in bonds and money market securities issued by the government, banks and other corporates.

There are various types of fixed income funds. Liquid funds, which invest in fixed-income securities that mature within 60 days, are the most stable in returns as they earn from interest accumulated on underlying securities. There is the ultra short term fund category which also has a similar structure. Most of the other debt funds earn from a mix of interest on underlying securities and the capital gains. "We talk to clients about maintaining a liquidity margin for contingencies. Apart from the savings account, some of this can go into liquid funds or short-term debt funds. There are many short-term goals that can be planned, such as down payments and vacations. Funds required for these can get invested in suitable debt funds," said Suresh Sadagopan, a Mumbai-based financial planner.

Returns from liquid funds are the most stable of all mutual funds, as they rely only on the interest accumulated from securities that are due to mature over the next 60- days. Hence, risk is low. However, returns can get negatively impacted by extraordinary events that impact systemic liquidity (like the 2008 global financial crisis). You may even lose money if you withdraw immediately after such events. But if you remain invested slightly longer, returns accumulate again once after the event risk tides over.

The biggest advantage is that you can redeem at any time. For most liquid funds, money is credited into your account within a day and asset management companies (AMCs) are bringing in innovative ways to reduce this time. Reliance Money Manager Fund and DSP BlackRock Money Manager Fund-both ultra short-term funds-allow instant redemption (subject to a limit of Rs2 lakh per day). So, money gets credited to your bank account almost immediately after you redeem.

Not just for liquidity
Short-term income funds are more useful for a 1- to 3-year kind of allocation. Historically,their returns have shown better performance than fixed deposits. Moreover, if eventually you don't end up redeeming within the expected time period, and remain invested for over 3 years, there are tax benefits to be had.

Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors, said, "The effective long-term tax on redemption of a debt fund is lower than what you would pay on interest earned from fixed deposits. Moreover, in a falling rate environment, this difference can add up to even more in absolute terms."

In a falling rate environment, debt funds gain from a positive change in bond prices. This gets reflected in the net asset value (NAV) of the fund, which increases, and you gain on redemption.

Deepali Sen, founder, Srujan Financial Advisers, said, "Given that funds are market linked, there is a potential to get higher returns, which is not there in a fixed deposit." Sen prefers liquid and ultra short-term funds over short-term income funds. However, there are risks as well.

Long-term income, gilt, credit opportunities and corporate bond funds are riskier than others, and are better utilised towards tactical allocation to take advantage of short-term market opportunities. You need to know when to buy and when to exit; these are not suited for stable return allocation. To find the debt fund that suits your requirement appropriately, other than the structure of the fund, also consider the experience with the asset management company and the fund manager's performance track record.

Additionally, debt funds have a degree of credit risk, which essentially measures the probability of default in payment by a bond. Always check the credit rating profile of securities held in debt funds before you invest. First-time investors should pick funds with a high credit rating profile. Lastly, some funds will have an exit load that you need to pay if you withdraw within a specified period. Check these details and invest.


In arrangement with HT Syndication | MINT