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Provide Stability to Investment with debt Mutual Funds SIP
Start investing small sums in debt funds at regular intervals and make big gains.
Most of us are aware of the benefits offered by systematic investment plans (SIPs). One, they offer the convenience of investing small amounts regularly over a long horizon to build wealth. Two, as the investment takes place across market cycles over a period of time, they can help lower the average cost of purchase.
While investing through SIPs is typically associated with equity funds, experts say that debt funds can offer the same advantages. There is a lot of potential in the debt fund space for retail investors. The outlook on both equity and fixed income is positive now. However, the benefit of averaging out the cost of purchase through SIPs is lower in case of debt funds compared with that for equity funds.
Big Returns
The bond market tends to move in cycles and can be volatile, but not as much as the stock market. It plays on interest rate cycles--when the rates climb, bond prices move south, and vice versa--and predicting this movement is not easy. This lends a degree of risk to a lump-sum investment in a bond fund. If, for instance, you happen to invest at the height of an interest rate cycle, you may subsequently see a sharp drop in the value of your investment. However, if you take the SIP route, you will be in a position to ride out the entire rate cycle.
Experts reckon that it is a good opportunity for debt fund investors to make big gains over the long term. If you want to benefit from the immediate effects of the expected rate cut by the RBI, a lump-sum investment in a debt fund would make more sense. However, if you were to hold on to your investment for a longer term, the gains would eventually fizzle out. So, a long horizon would merit a SIP approach. If you are investing for a specific need with a 6-12 month horizon, there is not much sense in opting for SIPs as there is little time for cost averaging to work. But if you are investing for a longer term, you should definitely have a SIP in debt fund as you will benefit from cost averaging and also have a limited surplus at the outset. Experts also suggest that instead of recurring deposits, investors should choose SIPs in debt funds. Instead of a recurring deposit with a bank, investors can start a SIP for an equivalent amount in a debt fund for the same duration, as these are more tax-efficient.
Enhance returns
Debt funds can also be used to one's advantage in other ways. According to experts, they can help enhance your returns. In a typical SIP mandate, regular transfer of money to an equity fund comes from an investor's savings bank account, where the money lies idle for the duration of the SIP, fetching a mere 4% interest. This effectively means that the value of your money is being reduced by inflation till the time you transfer it to an equity fund. This is where a debt fund can help. Set up a systematic transfer plan (STP) from a debt fund to an equity fund. First invest a lump sum in the debt fund and then the monthly investment amount can be directed towards the equity fund at a predetermined date every month. The amount invested in the debt fund is likely to fetch a higher a pre-tax return of 8-9%.
Similarly, debt funds can be used to withdraw money more efficiently from equity funds. Experts say investors should start an STP from an equity fund to a debt fund as they approach their goals. For example, if you have been investing in an equity mutual fund for your daughter's higher education, then 12-18 months away from the goal, you should start transferring the money gradually to a debt fund to ensure stability. This is useful because you cannot take the risk of equity markets tumbling over the next year, which could erode the accumulated wealth by the time your daughter is ready for admission to college. You may also use a systematic withdrawal plan (SWP) to exit from an equity fund, but that would involve transferring the money to your savings bank account, which will fetch a paltry return.
Taxation
When you transfer money from a debt fund to an equity fund, it is treated as redemption. If the transfer takes place before three years from the investment date, you are liable to pay short-term capital gains tax, at your tax slab rate. However, the STP approach would still work out better for individuals in the higher tax bracket. The post-tax return from a debt fund would trump the return on your savings bank account by a margin of around 200 basis points.
Besides capital gains, an exit load of 1-2% will also be applicable if you transfer from a debt fund to any other fund within a year or more of investment. Recently, many fund houses have increased the exit load tenures in order to align the product with the change in tax rules. However, some fund houses may waive the exit load to encourage investment in their own funds
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