Though debt funds have got their own advantages, they are mostly ignored by common investors. Debt funds have got a unique place in your portfolio. Here are five simple situations, in which debt funds can be used by prudent investors.
1) To meet short term goal:
If you have got a goal, which you are planning to achieve in a short term like one year or 2 year, then debt funds are the ideal place to invest. Debt funds are less volatile when compared to equity funds. Also you will have predictable returns. You also have a choice of different debts funds which can be matched to different short term horizons like 1 month, 6month, 9months, 1 year, 18 months and so on.
You can’t take risk and invest your short term money in stock market. You need ensure safety and liquidity as far as short term investments are considered which is very much there in debt funds.
2) Any Time Money:
Under some circumstances, you may not know when the need for the money will arise. But when the need arises, you may need the money at short notice. Say situations like the down payment money which you keep it when searching for a property.
Debt funds are the ideal place to keep our emergency reserve. Now-a-days liquid funds of a few mutual fund companies come with debit card facility. So you can keep your entire emergency reserves in these kinds of debt funds.
3) Lesser Tax than FDs:
If you fall under 20% or 30% tax bracket, then debt funds make more sense for you when compared to fixed deposits. The fixed deposit interest will be added to your income, and taxed at the tax bracket you are falling under whereas the debt funds if invested for more than one year will be taxed at 10% without adjusting for inflation. For less than one year, I will suggest you to invest under the dividend reinvestment option of debt funds. The reason is the dividends from debt funds are taxed at 13.51%.
The interest from fixed deposits will be taxed on accrual. Even on your cumulative deposit, you need to pay tax annually. As far as debt funds are considered, you will be taxed only when you actually redeem from the debt fund.
4) As a launching pad for large equity investments:
If you are planning to invest a lump sum amount in equity funds, then it is generally suggested that you should not invest the lumpsum in equity funds at one go. You need to stagger your investments in order to take advantage of the volatile stock market. So as to stagger your equity investment, you can use the debt funds as a launching pad.
That is you can keep the entire money in debt fund and slowly you can invest them into equity funds in a staggered manner. If you would like to do this staggering in a more systematic and sophisticated manner, you can opt for STP –systematic transfer plan. That is you can give a standing instruction to transfer a fixed sum from a debt fund to an equity fund periodically.
5) To generate regular income:
If you would like to generate regular income then debt fund is one of the ideal investments for you. You can get regular income by way of choosing dividend payout option.
One more way to generate regular income from debt funds is to opt for SWP from debt funds. SWP is systematic withdrawal plan which is the reverse of SIP. From a large sum of investment, you can opt to withdraw the appreciation or a fixed sum on a regular basis.
Debt funds play an important role in anyone’s portfolio which can’t be replaced by any other investment vehicle. So, next time when you come across any of the above situations, make use of debt funds to your advantage.
The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at firstname.lastname@example.org.