Debt Funds or RBI Savings Bonds?

I have invested in two debt funds-Templeton India Government Securities Fund and JM Income Fund. In the past six months, their returns have been just 3 per cent. Since there is no possibility of a drop in interest rates that could improve returns, should I switch to the RBI Savings Bonds?
Vinod

Yes, you have got a very valid point. Presently, the RBI Savings Bond are definitely a more attractive option than a gilt fund or a bond fund. Even though you have selected a pair of good funds, the uncertainty in interest rate movements has made debt funds a poor investment choice. Not only will returns be much lower than earlier, they will come in a more volatile manner. Thus, those who want decent returns with stability, RBI Savings Bonds could be a better option. Of course, you will have to compromise on liquidity-unlike debt mutual funds, these bonds have to be held for a minimum of three years and depending on the option, may have to be held for as long as six years.

RBI Savings Bonds    Option 1    Option 2 Rate of Interest   6.50%   8% Tax Status on Interest   Tax-free   Taxable Min Investment   Rs 1,000   Rs 1,000 Maturity Period   5 years   6 years Premature Withdrawal   after 3 years   No Max. Investment Limit   No Upper Limit   No Upper Limit

Currently, one option has an 8 per cent per annum return which is taxable and matures in six years and the other option has a 6.5 per cent annual tax free return and a five year maturity. The interest is compounded half-yearly and there is no maximum limit for investment in these bonds. While the 8 per cent bond must be held for the full six years, the 6.5 per cent one can be redeemed prematurely after three years are complete.

You should note that even after the lock-in ends, you do not have instant liquidity. Premature redemptions can only be made on the two biennial interest payment dates-January 1 and July 1.

This article was originally published on March 30, 2004.