We are at the peak of interest rate cycle after which we should ideally see decline in interest rates and this may happen in next few months. If you are looking for high returns and that too at a low risk, then this is probably the last call for you to invest in debt funds and fix your return at the highest rate possible; before Reserve Bank of India (RBI) starts cutting down interest rate in its monetary policy review. Although with 125 bps cut in the CRR, it is unlikely that RBI will cut interest rates in the upcoming monetary policy review meeting on 15th March 2012, but you will surely see the rate cuts sometime from April 2012. And the rate cuts in FY 2012-13 will not be less than 100 bps. So you have a chance to lock your investments at high rates as well as also benefit from falling interest rates.
But you need to be careful before rushing to your nearest bank in search of high interest rates on fixed deposits, as your post tax returns on fixed deposits of over 1 year may end up with negative real returns as average inflation is expected to continue to be around 7% to 8%. So you should look at avenues which can offer you high post tax returns or the one that offers high tax free returns. To your benefit this is possible through debt mutual funds And apart from debt mutual funds there are also Tax free bonds, Corporate FDs and various Post office schemes that can offer you returns better than bank FD. But in this interest rate cycle, the biggest question arises is- in which debt funds you should invest at this point of time.
Investments in debt funds can be sometime tricky considering the vast number and type of debt funds available in the market. Debt mutual funds that can beat your fixed deposit returns are categorised as Income funds (Short & Long Term) and Gilt funds (Short & Long Term), while other debt mutual funds category like Liquid, Liquid Plus, Floating Rate funds (Short & Long Term)are suitable for parking your short term surplus. And if you want to take some risk of equity for a better return than debt oriented hybrid funds or commonly known as Monthly Income Plans (MIP) are a choice for you. But a cautious point is that returns from debt mutual funds is not fixed or guaranteed and they are able to deliver high returns based on the expertise of the fund manager. Each category of debt mutual fund performs based on its mandate and quality of portfolio held and all debt funds may not match your investment need and time horizon. If you end up choosing a wrong kind of fund then it may hamper your financial goals as well. So investing in debt mutual funds require much more knowledge and expertise than what is required for investing in equity mutual funds as debt mutual funds are very sensitive to interest rate changes.
Before you jump on to invest in debt mutual funds please consider your financial goal and its time horizon. It is very important to consider the time horizon of your financial goal before investing in debt mutual funds as different type of debt funds are suitable for different time horizon. Let us illustrate you with the help of an example:
3 friends Mr. A, Mr. B and Mr. C have different financial goals and different time horizon for their goals. Please see the below mentioned table for the details of their financial goal:
|Name ||Financial Goal ||Time horizon ||Amount Required |
|Mr. A ||Own Marriage ||6 Months - 1 year ||5 Lakhs |
|Mr. B ||Car Purchase ||2-3 years ||7 Lakhs |
|Mr. C ||House Purchase ||5-6 years ||50 Lakhs |
Mr. A requires funds for his own marriage in next 6 months -1 year while Mr. B wants to purchase a big car in next 2-3 years and Mr. C wants to purchase his dream house in next 5-6 years. All 3 of them are very conservative in nature and want only fixed income instruments to achieve their goals. They do not want to take any risk with their hard earned money so they don’t want any equity exposure.
Considering different time horizon for their financial goals, they need to invest in different type of debt mutual funds which suits their investment objective.
Mr. A requires funds in next 6 months-1 year, which means liquidity of investment is a bigger concern than the investment return for him. Mr. A needs to invest in those funds which offer high liquidity so that money is readily available as and when required. So he should invest in Ultra Short Term or Liquid Plus funds which can provide him liquidity and a higher return than the interest he earns on his savings bank account.
Mr. B requires funds in next 2-3 years, which means he does not require any immediate liquidity of funds, but he does require a decent amount of return on his investments. He can go for a combination of Short Term Income funds and Long Term Income funds considering his time horizon of 2-3 years. This combination can provide him returns in the range of 8-10% p.a. over next 2-3 years. To match a similar post tax return, Mr. B can also look for highly rated corporate FDs which can give him fixed return of approx. 10% over next 2-3years.
Mr. C requires funds in next 5-6 years, which means he has long term horizon and needs to invest in instruments that can provide him good return over longer period. Mr. C has an option to invest in Bank FDs which will give him fixed return over next 5 years, he can also go for Corporate FDs which can give him 1-2% extra return than Bank FDs, but it will come at a bit higher credit risk than Bank FDs. Investing in FDs will remove reinvestment risk as the amount invested will be locked in at a current higher rate for 5 years. If he is willing to take a little bit of equity exposure which he can, considering 5-6 years of time horizon, he can go for Monthly income Plans (MIP) in which 15-25% will be invested in equity and the rest will be invested in debt. The equity exposure in MIPs can give boost to his returns which he can earn on his investments. Mr. C can also invest in combination of Bank / Corporate FDs and MIP, FDs will give him assured fixed return while MIPs due to its equity exposure can give a push to his total returns.
So you should not miss out this opportune time to benefit from high interest rates. And your investment in debt instruments should be based on your investment time horizon and risk appetite. Investing in debt mutual funds requires patience and also timely review and strategy. All debt mutual funds may not be suitable for all. You should know and clearly define your financial goals and time horizon before investing in debt mutual funds.
Please Note: Bank or Corporate FDs are a good option for those who come in 10% tax bracket, if you come in 20% or 30% tax bracket you should look for Long Term Income funds which will be taxed at 20% with indexation benefit on capital gains or 10% without indexation benefits.
If you are also considering investing in debt mutual funds, but don’t know which debt funds to opt for, you can either contact us for Personalized services or can opt for our online debt mutual fund research subscription i.e. DebtSelect.