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Invest in Long Term Funds before rates come down
With the stock market on a roll, a lot of investors are warming up to investing in stocks and equity mutual funds with high expectations. However, this still leaves a large number of people who are risk averse and are not willing to share any excitement of Dalal Street's euphoria. A downward trend for the interest rate is bad news for them as they get still lesser interest on their safe investments. Is there a way out for such people? Such people could look at some of the debt mutual fund schemes.
While most fixed interest rate investments tend to lose when interest rates fall, long-term debt mutual funds gain. Their high interest rate yielding holdings like bonds, NCDs, government securities (G-Secs), corporate debt instruments, certificate of deposits (CDs) and commercial papers (CPs) rise in value as the general interest rates decline and newer paper coming to the market are issued at lower interest rates. One can see that many long term debt funds are yielding more than 10% annualised returns. With the inflation drifting down and RBI feeling comfortable with its long-term trend, interest rates are likely to begin their downward journey and long-term debt funds will see their returns rise further.
There are some other benefits also. Debt funds are tax-efficient since indexation benefits are available for investments in these funds if one remains invested for more than three years. Going by the past trend, you are unlikely to have any tax burden on your profit if you remain invested for three years or more.
These funds are also more liquid than bank FDs, post office instruments, NSCs, PPF, etc. You can redeem your investments fully or partially any time and usually the money would be credited to your bank account in 1-3 days.
Debt funds give the investing reins in your hands. Here you can decide whether to go in for short term funds and thus have returns with almost no risk, or to take the interest rate risks and go for higher returns in long-term debt funds.
Liquid funds are another set of products that work like a savings bank, making your money available to you within one working day, while giving you more than double the returns of a savings bank.
In debt funds, you do not lose a single day's return even if you do not monitor it. Say you have a FD which has matured and you have neither renewed it, nor taken it out. In that case you will not get any interest on your FD amount, except the nominal savings bank rate. In open-ended debt funds, there is no concept of maturity and capital appreciation occurs till you actually take it out.
A few words of caution. It would be incorrect to assume that debt funds are risk free investments. If interest rates don't fall as quickly or as anticipated, there could be stagnant returns. There could be exit loads if one has to redeem earlier than was originally planned for. There could also be some tax burden on the profits made if redemption is done within three years of investing.
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