Does it Make Sense to SIP in Debt Mutual Funds?

Apr 27, 2023 / Reading Time: Approx. 10 mins

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Systematic Investment Plans, also known as SIPs, have become one of the most popular modes of investing among individual investors. The SIP folios have touched 63.6 million as of March 2023 (versus 52.8 million in March 2022), SIP contributions have risen to an all-time high of Rs 147.26 billion, and the SIP AUM (Assets Under Management) is at Rs 6.83 trillion as of March 2023. Thanks to the Mutual Funds Sahi Hai campaign of AMFI, and the emphasis on SIPs. But does it make sense for you, investors, to SIP in Debt Mutual Funds?

Before I shed light on that, first it will help to understand more about Debt Mutual Funds.


What are Debt Mutual Funds?

Debt Mutual Funds are a type of mutual fund that primarily invests in fixed-income generating instruments, such as government bonds, treasury bills, corporate bonds, certificates of deposit, etc.

There are a total of sixteen sub-categories of debt mutual funds -- such as Overnight Funds, Liquid Funds, Ultra-short duration Funds, Low duration Funds, Money market Funds, Short duration Funds, Medium duration Funds, Medium to Long Duration Funds, Long Duration Funds, Dynamic Bond Funds, Corporate Bond Funds, Credit Risk Funds, Banking and PSU Debt Funds, Gilt Funds, Gilt Funds with 10-year Constant Duration, and Floater Funds -- with each of these having a distinctive investment mandate and objective.

That said, broadly the investment objective of Debt Mutual Funds is to provide steady and regular income to investors. So, if you are averse to taking high risk (as in the case of equities), Debt Mutual Funds may be appropriate.

However, keep in mind, there is some element of risk involved (due to interest rate risk, credit risk, and liquidity risk) when you invest in Debt Mutual Funds; they are not 100% safe or risk-free. Hence, it is important to assess the risk you can afford to take, your liquidity needs, and set your risk-return expectations right.

Even when you do a SIP, the risk involved is not eliminated but only mitigated, i.e. reduced to an extent due to the inherent rupee-cost averaging feature of SIPs helping to average out the purchase price of units.

So, does it make sense to invest in Debt Fund SIPs?

SIPs may make sense only if your investment time horizon is longer, and depend on the sub-category of Debt Mutual Fund you choose to invest in. However, by and large, do note that the SIP returns could be muted in contrast to equity mutual funds.

Table 1: SIP v/s Lump Sum Returns of various debt mutual funds

Category Average 1 year 3 years 5 years
SIP (XIRR %) Lump sum (Absolute %) SIP (XIRR %) Lump sum (CAGR %) SIP (XIRR %) Lump sum (CAGR %)
Banking and PSU Fund 7.22 5.69 5.18 5.99 6.34 7.22
Corporate Bond 7.36 5.37 5.10 6.09 6.30 7.17
Credit Risk Fund 8.20 6.42 10.62 10.21 7.55 5.23
Dynamic Bond 8.15 6.53 5.51 5.74 6.54 7.23
Floating Rate 7.20 5.93 5.52 6.17 6.36 6.97
Gilt Fund with 10-year constant duration 9.53 6.32 4.27 4.47 6.22 8.11
Liquid 6.51 5.93 4.85 4.27 4.85 5.26
Long Duration 10.45 7.23 4.85 4.65 5.90 7.53
Low Duration 7.05 5.86 5.50 5.95 5.77 6.01
Medium Duration 8.44 6.87 6.65 7.13 6.36 6.16
Medium to Long Duration 8.74 6.89 5.42 5.73 6.26 6.90
Money Market 6.96 5.93 5.14 4.91 5.56 6.14
Overnight Fund 6.09 5.66 4.60 4.01 4.41 4.65
Short & Mid Term 8.44 6.24 5.06 5.13 6.58 7.94
Short Duration 7.72 5.99 6.10 6.62 6.48 6.64
Ultra Short Duration 6.75 5.86 5.19 4.98 5.47 5.69
Data as of April 26, 2023
Direct Plan and Growth Option considered.
Past performance is not an indicator of future returns.The table above is NOT a recommendation as such. Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, PersonalFN Research)

The table above indicates the kind of SIP returns Debt Mutual Funds have generated vis-a-vis a lump sum investment over the past few years. Usually, owing to less volatility compared to equity funds, debt fund SIPs might not generate attractive returns, particularly in the short term. In other words, the rupee-cost advantage does not necessarily work to your best advantage in case the NAV of the Debt Mutual Fund does not move up or down much.

The benefits of Debt Mutual Fund SIPs are only that...

1. It instils the discipline of investing regularly for certain financial goals (just as in the case of a Bank RD)

2. There are a variety of debt fund sub-categories for SIPs depending on your risk appetite and investment horizon

3. And may offer the opportunity to earn better risk-adjusted returns than a bank RD

Does it Make Sense to SIP in Debt Mutual Funds?
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Which debt funds are suitable for SIPs?

You cannot be investing randomly in Debt Mutual Funds hoping to clock higher SIP returns over the long term. The kind of returns would completely depend upon the sub-categories of Debt Mutual Funds you choose.

Typically, enrolling for SIPs in Credit Risk Funds, Medium to Long Duration Debt Funds, Long Duration Funds, Gilt Funds, and Dynamic Bonds, where the volatility in their NAV movement could be on the higher side (due to their inherent traits and portfolio characteristics), may make sense for SIPs. As seen in the table above, over the last few years, it is mainly the Credit Risk Funds that have clocked better SIP returns than lump sum returns.

On the other hand, shorter-maturity funds like Overnight Funds, Liquid Funds, Ultra Short Duration Funds, and Money Market Funds might not be suitable for SIP investments due to their inherent traits and characteristics of focusing on very short-maturity instruments.

[Read: 5 Best Low-Risk Mutual Funds to Invest in 2023]

What to consider when choosing Debt Mutual Funds for SIP?

Well, there are a host of quantitative and qualitative parameters you need to look at to make the best choice, such as:

  • Returns across time periods (3 months, 6 months, 1 year, 2 years, 3 years, and so on)

  • The risk ratios (Standard Deviation, Sharpe Ratio, Sortino Ratio, etc.)

  • The current interest rate cycle

  • The performance across interest rate cycles

  • The AUM and expense ratio of the scheme

  • The portfolio characteristics (who are the issuers, the sector they belong to, the type of debt papers held, the ratings of the respective debt papers, etc.)

  • The maturity profile of the fund

  • The credentials and experience of the fund management team

Moreover, it would do well to understand the forte of the fund house in asset management -- whether it is better at equity or debt -- plus understand its investment ideologies, processes, and systems.

In the evaluation process, if the mutual fund house lacks a robust risk management framework and depends excessively on ratings assigned by credit rating agencies, the fund manager compromises on the quality of the portfolio, chases yields, and plays down on the liquidity aspects of the portfolio, you should be concerned.

Want to know which are the Best Debt Mutual Funds to Invest in 2023? Click here.

How are debt mutual funds taxed?

As regards taxation of Debt Mutual Funds, after the passage of the Finance Bill 2023, Debt Mutual Funds are now at par with bank fixed deposits. The realised capital gains made on Debt Mutual Funds -- whether short-term (less than 36 months) or long-term (36 months or more) -- are now taxed as per your tax slab (i.e., the marginal rate of taxation).

Watch this video:


The indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability is now no longer available for Debt Mutual Funds.

[Read: Should You Consider Arbitrage Funds After Change in Debt Mutual Fund Taxation]

In conclusion...

Debt Mutual Funds are less risky, offer liquidity, and can help you address some of your short-term financial goals. If you have a low-to-moderate risk profile, you could build a suitable portfolio comprising various sub-categories of mutual fund schemes. But wisely choose your scheme and assess if making a lump sum or SIP investments would make sense. As mentioned earlier, SIPs may not make sense if your investment time horizon is less than a year and considering Debt Mutual Funds such as Overnight Funds, Liquid Funds, Ultra Short Duration Funds, and Money Market Funds. For a longer investment horizon, perhaps Medium-to- Long Duration Funds, Long Duration Funds, Gilt Funds, and Dynamic Bond Funds SIP may make sense if the volatility is expected to be high, credit risk is high, and the interest rate cycle may go either way.

It is important to recognise your investment objectives, risk appetite, the current interest rate cycle, investment horizon, and investment time horizon when investing in Debt Mutual Funds (irrespective of whether you do a lump sum or a SIP investment). If you follow a thoughtful and astute approach, it can prove to be a rewarding experience.

Happy Investing!

ROUNAQ NEROY heads the content activity at PersonalFN and is the Chief Editor of PersonalFN’s newsletter, The Daily Wealth Letter.

As the co-editor of premium services, viz. Investment Ideas Note, the Multi-Asset Corner Report, and the Retire Rich Report; Rounaq brings forth potentially the best investment ideas and opportunities to help investors plan for a happy and blissful financial future.

He has also authored and been the voice of PersonalFN’s e-learning course -- which aims at helping investors become their own financial planners. Besides, he actively contributes to a variety of issues of Money Simplified, PersonalFN’s e-guides in the endeavour and passion to educate investors.

He is a post-graduate in commerce (M. Com), with an MBA in Finance, and a gold medallist in Certificate Programme in Capital Market (from BSE Training Institute in association with JBIMS). Rounaq holds over 18+ years of experience in the financial services industry.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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