Start investing small sums in debt funds at regular intervals to make big gains in the long term

 

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 GAINS 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.

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 an SIP in debt fund. 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. Instead, 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. 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.

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.