Several people have been wanting to know about Debt Funds in Mutual funds for some time now. In this article, I will try to enlighten you about some very basic things about Debt funds. After reading this topic, those who think Mutual funds mean to share, hopefully, their notion will change. Many people are unaware of any other option for the short term except Bank Fixed Deposit. Read the whole article, then you will get an idea.
Concept of Debt Fund
The word “debt” means to borrow. If you lend money to someone, you will get interest. There is no relation of profit or loss with the debts. Debt is something from which you can get interest. Examples of debts are Fixed Deposit, Post Office Deposit, Bank Savings Account, etc.
You must have heard of Share Market, but let me tell you, the Debt Market is even bigger than that. You might have not herd about it because ordinary people can’t buy and sell in that market. Government, banks, big companies, and various financial institutions such as Mutual Funds can buy and sell in that market.
Debt means a contact paper having a time horizon. For example, a Fixed Deposit has tenure and an interest rate. This is called the coupon rate in technical terms. Just the way one can withdraw from a bank’s fixed deposit scheme, you can do the same from an open-ended Debt Fund before tenure.
In addition to the interest in the Debt Fund, another income is called yield. Don’t panic, I’m trying to explain. I have already said that a Debt fund is bought and sold in the market, so the market value of the Debt fund also changes to increase or decrease the interest rate. That’s called yield.
Who Issues this Debt Paper? It is issued by the Government of India, various financial institutions, and big companies for their project and collects their required money from the market and in return they pay interest. The paper that the government leaves out is called Gsec paper or Government Security Paper. The Government collects a % of GDP from the market through this paper to control the economy or to meet its fiscal deficit.
Suppose the government has released a 9% paper in the market for a 10-year tenure, the price of which is maybe 10 rupees. Suppose Mr. X has invested Rs 10,000 in that paper. That means Mr. X got 1,000 papers at a 9% rate with a market value of Rs 10. After one year, maybe the interest rate will decrease and the government will again release another paper of 8% for a 10-year tenure where the price of one bond is 10 rupees. Now Mr. Y wants to invest Rs 10,000. He sees that if he invests in this newly issued 8% Paper, he will get 8% Interest but if he can buy the previous 9% Paper from the market then he can get 9% interest. But he finds that the price of that 9% paper in the market is not 10 rupees then he has to buy it for 12 rupees because many more people like him in the market want to buy it then.
Now think Mr. X 900 got an interest of Rs. 900 at a rate of 9% on Rs 10,000 in one year, just like a fixed deposit. This is the advantage of a Debt Fund. He invested 10,000 rupees and got 2,000 + 900 = 2,900 rupees in return.
There is a huge possibility of reducing the interest rate at present. There are many technical reasons for this. Without going further into them, it can be said that inflation is under a lot of control now and the target of RBI is to keep Inflation in plus-minus10-year 2% to 4% in the coming days. If the interest rate is 7.5% to 6% today, think about how much yield you can get. In addition, there is the benefit of tax. I think it is a very good opportunity to invest in a straight way Debt Fund for 3 years tenure.
Different Types of Debt Fund
Let me introduce you to some of the Debt Funds included in the Mutual Fund.
Money Market, Cash or Treasury Management, Floating Rate Funds are called Liquid Funds. This fund’s money is invested in a very short-term paper. So the interest rate increasing or decreasing volatility is very low. Any money can be deposited or withdrawn at any time like a Savings Account. But in a Bank Savings account where 2.75% interest is available here in a tax-effective way is way better than the return is available. Practically, there is no chance of losing capital but you can enjoy 50% more return from a Bank Savings Account.
If you want to know more about Liquid Funds, click on the link below.
Fixed Maturity Plan (FMP)
This is a fund like a Fixed Deposit. It also becomes mature after a certain period. Generally Fixed Deposit Plus Return is well available here. Tax benefits are also much higher. This is a Close Ended Fund. This means that you can only invest when this fund is issued.
All the money of this fund is invested in Government Bonds i.e. Gsec Paper. Its security is much higher
Usually invested in Medium or Long Term in Bond Paper with higher interest rates.
Dynamic Bond Fund
In this fund, the Fund Manager understands the nature of future interest rates and invests for Medium and Long Term
After reading this, one will have to invest in the Debt Fund at one’s own risk. There are some technical issues besides Debt Fund Liquid Fund. For example, it is important to examine the portfolio of the type of paper they are investing in.
How Debt Fund Is More Tax Effective Than Bank FD
This time I am highlighting a practical matter. I will tell you why Mutual Funds Debt Fund is so popular with banks or post offices. Where does the benefit lie? Try to understand the matter without focussing only on the interest rate of any product. I would urge everyone to read this post later if anyone is busy now, to understand this matter over and over again. Suppose someone started a bank FD in 2013 for 3 years at an 8% interest rate of Rs.1,00,000. He has decided to take 1 lacs rupees with interest upon maturity after 3 years. Suppose after three years the maturity value of that FD is approximately Rs. 1,25,971. That means his Gain is (1,25,971- 1,00,000) = 25,971 rupees. Now, this is not his real gain, because his total income is in taxable slabs and not in any bank or post office. After deducting 10% TDS on that gain, you will get the rest. Yes, if you submit a 15G / 15H form then TDS will not be deducted but you have to file a return, right? Even if it is nil. If you get a 10% tax slab, you will have to pay a tax of Rs 2,597, and your net gain will be 7.20% or Rs 23,373. If the tax is at 20%, the tax rate will be Rs 5,194, and net gain will be 6.40% i.e. Rs 20,776. If 30% is tax rate,then Tax will be Rs 7,79, with net gain will be 5.60% or Rs 18,179.
Now if you keep that Rs 1,00,000 in Mutual Fund’s Debt Fund for 3 years, see what happens. Let’s say you get the same 8% return here, too. Then the maturity value will be the same as the FD i.e Rs 1,25,971. But here the tax calculation is different. There’s a benefit called Indexation Benefit which is published by the Government of India every year. For example, since this investment was made in 2013, you have to look at the index value of that year. The Index Value for that year was 939 and for the maturity year 2015, the Index value for that year was 1081. This time, like FD, by deducting the Principal Value directly from the Maturity Value (1,25,971- 1,00,000) = Rs. 25,971. The calculation will be in the unitary method. This time gain will be (1,25,971-1,15,122) = 10,848 rupees. Hopefully, you are not having difficulty in understanding. In FD, the tax was calculated at the Income Tax Slab Rate on gain. Tax is also to be paid at a 10% tax rate in FD at Rs 2,597 here Rs 2,170. Those who belong to the 30% tax slab have to pay Rs. 7,791 in FD and here the tax is only Rs. 2,170. Can you imagine? If the difference is only 1 lac, then do you understand what will happen if the amount was 10 lacs or more?
Now if someone withdraws the interest quarterly or monthly and invests for less than 3 years, then the amount of tax in the Debt Fund will be much less. Suppose someone started an FD in 2014 with Rs. 1,00,000 at 8% rate. Suppose, he is getting Rs 8,000 as interest for 1 year. His tax will be fixed at Rs 800 if it is 10%, Rs 1,600 if it is 20%, and Rs 2,400 if it is 30%. But what will happen to the Debt Fund? Suppose, someone invests Rs.1,00,000 in a Debt Fund and earns Rs.8,000 at the same 8% Return Rate and withdraws that Rs. So what will be the tax implication?
When the gentleman invested in the Debt Fund, suppose the Purchase Price (NAV) of the Fund was Rs 10. Now after that one year when he is raising Rs 8000, there has been an 8% growth of that fund. Is that so? Isn’t anyone having trouble? Now see how the gain will be calculated here. For the 8,00,0 rupees he is raising, he is raising a unit (8,000 / 10.80) = 740.7407 units. The purchase price of those units was 10 rupees (740.7407 unit X Rs 10) = 7407 rupees which mean the gain will be (8,000-7407) = 593 rupees. Now on this Rs 593, whoever owns 10% tax rate will have to pay only Rs 59 on tax, whoever owns 20% tax rate will pay Rs119 on tax, and tax at 30% will be Rs 178. Can you imagine?
There are two reasons for writing this article, one is to give an idea about Debt Fund and to try to put an end to this misconception that Mutual Fund means only Share. In my opinion, a person earns 100 rupees without any planning or purpose and invests 10 rupees according to the ideas he has heard before and a person invests by planning in a proper scientific way, both have different results. Keep in mind that a conscious investor can be a protected investor.
Frequently Asked Questions
Many people have asked many questions, I am trying to answer them below.
Q. Is it good to invest in debt mutual funds?
A. Investors who do not like the volatility of equity. For them, this Debt Fund can be ideal. For those who like to invest in fixed deposit type products, Debt Fund can be a very good option.
Q. Are debt mutual funds safe?
A. There is not as much volatility in Debt Fund as there is in Equity. From that point of view, it is safe. Moreover, if money is invested in a fund with AAA + rated paper, then safety increases.
Q. How does a debt mutual fund work?
A. To get a proper answer to this question, I request you to read this blog article more carefully.
Q. Which is a better, FD or debt mutual fund?
A. Of course Debt Fund is much more useful. I have discussed this in detail with the example in the above blog, once you read it, you will have a clear idea.
Q. Which is the safest debt fund?
A. Any Debt Fund with Overnight funds, Liquid Fund, Fixed Maturity Plans, or good quality paper are safer.
Q. Why are debt mutual funds falling?
A. I think this question has been asked to find out why the value of the Debt Fund is often reduced. One reason is low-quality debt paper. If there is a large amount in the Fund and if the paper cannot return the money upon maturity, then the value may be less. Secondly, for fluctuation of interest rate, the temporary value becomes lesser.
Q. Is it a good time to invest in a debt fund?
A. Yes, there is a chance to reduce the interest rate a lot in the future.
Q. Are debt funds safe during a recession?
A. Of course, when it comes to recession in the economy, people give priority to safety first. A debt fund that has been invested in Good Quality Paper in this situation can give very good results.
Q. What is the difference between equity and debt funds?
A. Equity Mutual’s money is invested in various Stocks or Shares. Equity means ownership. The owner gets profit if it is profit and loss if it is a loss. Debt means to borrow and profit-loss has nothing to do with borrowing. Debt means that the money that has been lent will be repaid at maturity and with it, the interest will be available for as long as the money is not repaid.
Usually, investment is done in an Equity Fund for the long term whereas Debt Fund is used to keeping deposits in the short term. Equity Fund has the potential to get higher returns in the long run, so the risk is a little higher than that. The probability of getting a moderate return with low risk in the Debt Fund is much higher.