When it comes to mutual funds, investors often face the dilemma: which scheme is for me? While investing, it’s extremely important to pay attention to the scheme you choose. With numerous options available, finding the right one for you is always a question. Mutual fund schemes could vary from equity to debt to hybrid funds.
Before choosing a scheme, one should assess various factors such as return expectations and risk appetite. Traditionally, debt funds were the choice for risk-averse investors as they offered stable returns compared to inflation with minimal risk. However, the Union Budget 2023-24 brought changes in tax rates, prompting investors to look at schemes in a new light.
Debt funds acquired after April 1, 2023, face a stringent tax regime. The gains from “specified mutual funds” (those with less than 35% equity exposure) are now taxed as short-term capital gains based on the investor’s income slab rate, which can be as high as 30%. Furthermore, after three years, debt faces a 20% long-term rate, without any inflation-adjusting indexation benefit, which was a comfort for long-term investors. These changes initially intended to create a fairer landscape with direct investments, have inadvertently shifted the balance towards equity investments.
On the other hand, equity has a clear advantage: short-term capital gains face a manageable 15% levy, and long-term gains exceeding Rs 1 lakh are taxed at a mere 10%. While both equity and debt offer opportunities for wealth creation, the disparity incentivizes risk-averse individuals to chase equity returns solely for tax benefits, potentially pulling investors towards equity as an easier available option.
While there are certain benefits, there are also risks associated with choosing short-term over long-term options. Chasing short-term equity gains driven by tax benefits might create a barrier to long-term wealth creation. Diversified portfolios with low-risk, tax-efficient instruments like balanced funds or tax-free bonds get ignored, potentially leading to significant losses.
Why debt funds:
With the increasing participation in mutual funds, one should also consider adding debt to their portfolio. Here are a few government initiatives to support this idea:
The SEBI has taken two key steps to boost retail participation in corporate bonds: first by slashing the minimum investment size to Rs 1 lakh and regulating online platforms to protect investors from illiquid, unlisted debt. These initiatives provide confidence to retail investors by offering access to attractive bond options with enhanced safety.
Furthermore, the revamped Request for Quote (RFQ) process grants retail investors access to a broader spectrum of debt instruments, including corporate bonds and government securities. This diversification helps investors make better decisions and caters to a wider range of risk appetites.
Additionally, digital platforms are democratizing debt investments by eliminating intermediaries and simplifying the process of buying and selling bonds.
Beyond attractive returns, debt offers crucial advantages:
Debt provides predictable cash flows that support your long-term financial plans, ensuring stability. Your principal investment remains largely safe since the outcome is returned after a certain tenure, protecting you from significant losses, and ensuring capital preservation. Balancing volatility and mitigating risk, debt strengthens your overall portfolio, providing diversification.
Conclusion:
We can conclude that debt instruments are no longer just for risk-averse people. They are one of the preferred options for diversifying the portfolio. As equity has always dominated individuals’ portfolios, one should consider adding debt to the portfolio.
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.
