There are a large number of instruments that an investor can choose to invest in. Many factors go into determining the right product but primary considerations are investor’s risk appetite and time to payout. Debt Mutual Funds are a good choice of investment for individuals who want medium return at low risk.
Debt mutual funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. For the risk-averse investors debt mutual funds are better alternatives to fixed deposits due to following reasons:
HIGHER LIQUIDITY AND FLEXIBILITY THAN FD
Debt mutual funds have higher liquidity - you can withdraw your investment in part or in full and the money will be credited to your account the next day. Debt funds are also more flexible than fixed deposits since you can invest small amounts every month by way of an SIP or whenever you have surplus cash. Opening a fixed deposit every time you have some extra cash in your bank account is impractical. Additionally by moving your money into debt funds, you don’t lose a day’s growth.
In the long term, debt funds are far more tax efficient than fixed deposits. Income from investment above one year is treated as a long-term capital gain and is taxed at either 10% or at 20% after indexation. Income from fixed deposits is taxed on an annual basis whereas in debt funds, the tax is deferred indefinitely till the units are redeemed.
RETURNS CAN BE HIGHER
The pre-tax returns from debt funds are comparable with those from other debt options such as fixed deposits and bonds. Short-term debt funds are not affected too much by interest rate changes in the economy and investors continue to gain from the accrual of interest. But funds that invest in long-term bonds are more sensitive to changes in interest rates. If interest rates decline, the value of the bonds in their portfolio shoots up, leading to capital gains for the investor.
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