Debt Mutual Funds are the funds which invest in debt instruments such as Treasury Bills, Government securities, Certificate of Deposits (CDs), Commercial Papers (CPs), bonds, money market instruments.
However, retail investors cannot make direct investment in select instruments. They can do it through investing in debt mutual fund.
They are called 'debt' as the issuers have borrowed money from the lender (investors) by issuing these instruments.
Why They Are Better Than Bank fixed deposits?
For a conservative investor, fixed deposits are the most preferred instrument considering the interest income and safety of the instrument.
Now, let us see how debt funds are better.
Debt Mutual Funds can be liquidated as and when required and the amount will be credited to the account. Many mutual funds houses do not charge if the fund is older than specified months.
Many banks charges pre mature withdrawal fees and paperwork is needed for higher amount withdrawal. Also, you may end up with less interest rate than expected.
Safety of capital
Bank Fixed deposits are considered as safe instrument as it is backed by the government. However, the RBI assures of an amount to the extent of only Rs 1 Lakh.
Debt funds are rated by rating companies like ICRA, CRISIL, CARE etc. A higher credit rating indicates lower issuer default risk and vice-versa. One can pick funds with high credit rating.
While, one should not forget debt funds are exposed to credit risk and interest rate risk.
Tax Post Returns
Debt Mutual funds are taxed according to tax slabs if held for less than 36 months.
In case of bank deposits, an investor needs to pay taxes on accrued interest each year.
In the Budget, Arun Jaitley proposed to increase the long-term capital gain tax on debt mutual funds from 10 per cent to 20 per cent.
Means that debt mutual funds are taxed at 20 Per cent with indexation. While, short term capital gains are taxed as per the tax applicable for individual investor
Note that short-term capital gain of a debt fund is added to the income and then taxed as per your tax rates.
While, for long term capital gain tax, it is calculated 20% with indexation.
Debt funds offer higher flexibility than fixed deposit. One can choose from the options like Systematic Investment Plan or Systematic withdrawal Plan.
One have the flexibility to move from one fund to another fund considering the markets and prevailing interest rates.
However, there is a cost involved in maintaining a debt mutual fund. Debt Mutual fund is for those individuals who are looking at moderate risk, good return and capital appreciations on his funds.
If only capital protection matters, he should go for fixed deposits.