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Investing in debt mutual funds instead of directly investing in bonds

Ashutosh Gupta sheds light on the advantages of investing in bond funds vis-à-vis direct bond investments

For regular income post-retirement, why should one invest in a mutual fund when investing directly in bonds can fetch regular interests as well as the principal amount at the end of the tenure? On the other hand, in mutual funds, you can exhaust the entire amount in the SWP mode.
- A K Gopal

Firstly, the rate of interest from a bond or the rate of return that you can get from a bond does not change irrespective of whether you invest in it directly or indirectly through a vehicle like a mutual fund. Now what debt mutual funds do is to convert the interest income from a bond into capital gain, which over a longer holding period of more than three years is actually beneficial from the taxation perspective. So, if you hold a fixed-income fund for more than three years, then the capital gains that you derive from it are taxed at the rate of 20 per cent after providing the indexation benefit, which is beneficial tax treatment.

The second advantage a bond fund offers over directly investing in bonds is that of diversification. Now because of the limited investments of an average retail investor and the large ticket size involved in investing in bonds directly, one may not be able to diversify adequately by investing directly in them. However, in the case of a mutual fund, even with small investments, one can achieve diversification by investing in a basket of bonds.

The third benefit of mutual funds is liquidity. Of course, barring incidents like the Franklin episode, a mutual fund stands committed to honouring your redemption at the applicable NAV on any working day. So, those are the kind of advantages that you get by investing in a debt fund over investing directly in bonds.
Now coming to his point around exhausting his investments in a debt fund through the SWP. Well, that would be a function of your withdrawal rate in the first place. If one restricts one's annual withdrawals through the SWP to the tune of broadly the kind of returns that a debt fund is able to generate, then he would not end up exhausting his corpus.

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