How many of you think that debt funds are not as good as equity funds just because they give lesser returns?

Well, in this analytical article, we highlight the importance of debt funds and shed light on how important a component it is in an investor’s portfolio.

As most of us know, debt funds decrease the risk factor associated with your portfolio, as a form of government debt is usually considered to have the least risk.

What Does Our Analysis Show?

We have performed a small analysis of 3 different sample portfolios.

In this analysis, we have chosen 3 portfolios to have varying amount percentages of debt funds.

Each portfolio has holdings in small-cap, mid-cap, and large-Cap in the ratio of 1:1:3

To show how debt funds can help balance out the risk factor of your portfolio, we have simulated a market recession similar to the one occurring in 2008, and we see how the percentage of debt funds in your portfolio affect the amount of loss made during a recession period.

How Will Debt Funds Perform If a Recession like That of 2008 Were to Hit the Economy?

 

Small-Cap

(HDFC small-cap fund)

Mid-Cap

(L&T Midcap Fund)

Large-cap

(SBI Blue-chip Fund)

Debt Fund

(Franklin India Ultra Short Bond Fund)

Portfolio 1

33% 33% 33% 0%
Portfolio 2                  10%

10%

30%

50%

Portfolio 3 15% 15% 45%

25%

Let the total investment amount Rs 15,00,000.

After designating the appropriate amount of money to debt funds, the remaining money is divided in the ratio of 1:1:3 between small Cap, Mid Cap and Large Cap respectively.

The Investment Amount Per Mutual Fund of The Portfolio Is Shown Below.

Small-Cap
(HDFC small-cap fund)
In Rupees
Mid-Cap
(L&T Mid-cap Fund)
In Rupees
Large-cap
(SBI Blue-chip Fund)
In Rupees
Debt Fund
(Franklin India Ultra Short Bond Fund)
In Rupees
Portfolio 1 3,00,000 3,00,000 9,00,000 0
Portfolio 2 1,50,000 1,50,000 4,50,000 7,50,000
Portfolio 3 2,25,000 2,25,000 6,75,000 3,75,000

The result is shown below in the form of a graph:

From our analysis we can infer that

Portfolio 1:  Which has 0%  Debt Funds has a net return of Rs 6,20,701.8

Portfolio 2 : Which has 50% Debt Funds has a net return of Rs 11,05,384.

Portfolio 3: Which has 25 %  Debt Funds has a net return of Rs 8,67,043.

Therefore portfolios with a higher percentage of debt funds are comparatively less risky.

This goes on to prove that a smart investor always has the right balance of equity and debt, so that even during the rough times of the market, the amount of loss may be minimized.

Hence, a smart investor always considers his/her risk appetite and curates his/her portfolio so as to fit his or her needs perfectly. Therefore, keep in mind that debt Funds makes your portfolio less risky.

Why Do I Invest in Debt Funds?

1. Less Volatile

Debt funds are preferred by individuals who are not willing to invest in the highly volatile equity markets. A debt fund provides a steady but low-income, relative to equity. It is comparatively less volatile.

2.Tax Benefits

In terms of taxation, debt funds score better than bank FDs.

If you hold your investments for more than 3 years, you just need to pay only 20% capital gains tax (with indexation benefits).

Since you take indexation benefit (that means adjusting the cost of your investment for inflation), your ‘real’ tax outgo will be far lower than the 20 percent.

Be it in terms of liquidity, superior returns or tax benefits, debt mutual funds score over passive bank deposits.

Diversify your traditional debt holding with these schemes, based on the time frame of investments to take advantage of them.

The various types of debt funds are:

  • Gilt Funds
  • Long-term income funds
  • Dynamic Bond Funds
  • Short-Term Funds and Liquid
  • Ultra short-term funds

Gilt Funds are the riskiest of all debt funds and have the highest returns among all. Liquid and Ultra short-term funds are the least risky and hence have the least returns.

3. Various Options

There is a wide range of debt funds available to investors who are seeking low-risk income investments within the fixed income universe. Similar to other asset categories, investors can generally turn to passive and active investment products.

4. More Efficient than Fixed Deposits

In the long run, debt funds are far more tax efficient than fixed deposits. After one year of investment, the income from a debt fund is treated as a long-term capital gain and is taxed at either at 20% after indexation.

In indexation, the cost of investment is raised to account for inflation for the respective period that investment is held for. The longer you hold a debt fund, the bigger is the indexation benefit.

5. No TDS

There is no TDS in debt funds. If your interest income exceeds Rs 10,000 a year, the bank will deduct 10.3% from this income and no more.

Happy investing 🙂

Disclaimer: The views expressed in this post are that of the author and not those of Groww