I always believe that it’s the right of every investor to get the right rewards for their investments. I apologize that you will have to read the 3 pages rather than one to understand it fully, at the same time I assure you that these 3 pages will make you well-equipped to understand the asset class which could be way better than fixed deposits. We call it debt funds.
The learning from the article:
- What are the debt funds?
- Why debt funds are being loved by the veteran investors over fixed deposits?
- Why it’s the best time to invest in debt funds?
- The most important mystery at the end of the article.
What are the debt funds?
Debt markets are the evolved form of banking system. The following chart says a lot:
Whenever corporate or Govt. needs the borrowings, they can go either to the bank (who puts lot of conditions and charges higher interest) or to the public directly. The latter removes the intermediary (the bank) and borrows money from the investors directly, in technical terms we call it bonds/debentures. It helps the both parties (investor and borrower) to share the benefit of the intermediary, which bank holds.
Now, the obvious question must be striking in all of your minds. That bank knows the risks. The bank knows which party to lend and to which not. How can we do the job of the bank? If this question didn’t strike in your mind, it should.
The answer lies in debt funds rather than choosing any particular debenture/bond at your own. The debt fund manager is equally qualified like any bank, which studies all the options/risks before buying the bonds of any corporate. It helps in mitigating the risks. Secondly, he invests in multiple bonds to mitigate the risk further.
Why debt funds are being loved by the veteran investors over fixed deposits?
After all this basic Gyan, comes the lucrative part, why debt funds are favored by the experienced investors. The answer lies in the taxation. Debt funds are the tax efficient instruments rather than fixed deposits. Even if the both debt funds and fixed deposits provide the same returns, investors get the better post tax return in debt funds. I am sharing the following table to understand the same:
| Details | Fixed Deposit | Debt Funds |
| Investment (INR) | 10,000,000 | 10,000,000 |
| Annualized Return | 7% | 7% |
| Period (Years) | 3 | 3 |
| Tax Rate (Income above 15 lacs) | 31.2% | 20.8% after indexation |
| Tax Deduction | Every Year | Only at the time of redemption |
| Return Before Tax | 12,250,430 | 12,250,430 |
| Indexation cost (2022-23 to 2026-2027 at 5%) | 12,155,063 | |
| Tax | 734,931 | 19,836 |
| Final Value After Tax | 11,515,499 | 12,230,594 |
| Return After Tax | 1,515,499 | 2,230,594 |
| Annual Post Tax Return (%) | 4.8% | 6.9% |
| Difference in Return (INR) | 715,095 |
In Fixed Deposits, you end up paying higher taxes as compared to nominal taxation in debt funds. It creates the huge difference in the final returns, which you can easily witness from the above table.
Why it’s the best time to invest in debt funds?
Now, comes the even better question, when to invest in debt funds. Debt funds don’t beat the fixed deposit return always. The best time to invest in the debt funds are when interest rates have already peaked to the upper limit and may decline in the future (to know more about this, feel free to contact me). Now all of you know that interest rates have increased in past year. At the same time, many financial experts feel that we at almost the peak of the interest rates. From here interest rates may pause for a while and we may witness the interest rates coming to lower side in 2024 & 2025. This is called the batsmen pitch for the debt funds. In these times, debt funds provide way higher returns than fixed deposits.
Earlier we discussed the level playing field where even at same returns, how debt funds provide much better returns than fixed deposits due to taxation only. Now, as we entering into the best times for debt funds, we can very easily witness 1-2% extra returns in debt funds over and above the 2% return (taxation benefit).
The most important mystery at the end of the article:
Debt funds are the big markets. It has a lot of categories and it takes the deep down research to get the better results. It’s more important to choose the right category within the debt funds and pick the right fund in that particular category.
As we say, ‘Mile wide and Inch deep’ or ‘Inch wide and mile deep’, infact the best part is being deep in both. I have tried my level best to cover the earlier with this article. The latter needs the in depth knowledge and experience. To know more or to invest in the right debt funds, feel free to contact.
-Manish Bansal (9988223448)