Saturday, July 1, 2017

TIME TO SAY GOODBYE TO FIXED DEPOSITS & EMBRACE DEBT MUTUAL FUNDS?



The recent demonetisation drive by our government has benefitted banks the most as SBI alone reported garnering deposits more than Rs. 1.2 lakh crores in 10 days. It has been estimated that the combined banking system will receive deposits of more than Rs. 4 lakh crore. By curbing the cash withdrawal limit, the biggest impact will be on the consumption which is expected to bring down inflation below 4% by December end. The chain effect of all this is expected to lead RBI to reduce rates in the next monetary policy meet scheduled in December 2016.
Banks have already started reducing interest rates on deposits as they now have excess money which must be ultimately lent to borrowers. Our country’s biggest bank – SBI has already reduced rates on fixed deposits to less than 6% for tenures of 1 year and above. Other banks are expected to follow and reduce their interest rates too. Where does this leave the investors, who have been religiously investing in Bank Fixed deposits for safety and fixed income purpose? Do fixed income investors have an alternative now which can help them earn better than FDs and provide the safety net that banks used to provide? The answer lies in Debt Mutual funds.
Debt mutual funds are schemes which invest predominantly in fixed income instruments such as treasury bills, certificate of deposit, debentures, corporate and government bonds, etc. Depending on the nature of the scheme the investments are done accordingly.
Investors can invest in these debt schemes as per their time horizon and after understanding the risk factors associated with it.
1.       Liquid Funds: These funds ideally invest in very short term securities such as treasury bills issued by RBI and Certificate of deposit which carry a fixed return. These funds are ideal for investors who want to keep aside idle cash rather than maintain in savings account. Also, if you have plans to do a major purchase in next 1-2 months then too the funds can be maintained in these funds as the funds get credited into the account the next day on redemption. Secondly these funds are currently providing a return in the range of 7-8% annualised which is much more than savings account.

2.       Ultra-short term funds: These funds invest in securities of duration ranging from 3 months to 6 months and primarily invest in debentures, certificate of deposits and commercial papers too. If you have a 3 to 6 month holding period, then these funds are ideal with a return potential like liquid funds and higher at times.
3.       Short Term funds: If one has a time horizon of 1 to 2 years then these funds are ideal as they invest in securities of slightly higher duration which can be more than 1 year. These funds invest in debentures, bonds and even government securities. These funds are ideal investments against 1-2 year Fixed deposits as they return more than ultra-short term funds. These are much safer than most other long term debt funds.
4.       Accrual funds: These funds are also known as credit opportunities funds as these funds primarily invest in debentures and bonds of corporates. The ideal tenure for such funds should be 3 years and above as these funds invest in rated bonds with the intention of earning a regular fixed income (accrual). While investing in these funds care should be taken to check the ratings of the securities held in the portfolio and only those holding AAA rating should be considered. Some of the securities in the portfolio may face credit risk and hence investors with utmost safety in mind should avoid such funds.

5.       Dynamic Bond funds: To overcome the risk faced by Gilt funds, Dynamic bond funds have been created. These funds dynamically manage the different bonds in the portfolio as per market trends and situations. In the current situation, these bonds are best suited to ride the trend and give better returns.

First time investors will do well to stick with ultrashort and Short term debt funds and the level of safety is high and returns volatility is minimum. For investing in accrual and dynamic bond funds, one has to understand the pros and cons of  how these funds perform in changing interest rate scenarios and therefore should be considered only by an informed investor.

Apart from good returns over Fixed deposits, debt funds have a more favourable taxation structure. If the debt funds are held for more than 3 years, then the gains on the funds are categorised as long term capital gain and tax must be paid at 10% on the gains or 20% after indexation. This is much lower than FDs as the entire income on deposits gets clubbed with your income and you are taxed as per your slab. In times of need you need not withdraw the entire amount like FDs but redeem what you need and rest remains invested. This is a good time to diversify beyond FDs but first do your due diligence and consult your financial advisor to select the right funds as per your needs.


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