Best Target Maturity Mutual Funds

You can consider investing in target maturity mutual funds if you are: 

• Averse to risks: If you’re more conservative as an investor, you may invest in these funds. This is because they allocate investments to higher-quality debt instruments. It naturally lowers your default risks significantly. 
• Planning to meet future objectives: In case you have a defined financial objective with a specific timeframe, you may choose these funds. Holding it until maturity may help you get the expected returns. 
• More predictability and stability: By holding your bonds to maturity, these funds are naturally less risky (in terms of interest rate volatility). As the fund nears its maturity date, tenure risk declines. This may help you get more stable returns. 
• Passive investment strategies: Target-maturity mutual funds aim to replicate underlying bond indexes without active management. It enables lower expense ratios than those of actively managed funds. This may yield better returns in the long run. 
• Better tax efficiency and liquidity than FDs: For holding periods beyond 3 years, these funds previously offered inflation-indexed LTCG benefits. Based on the 2023 taxation changes, gains from debt funds will be taxed as per your income tax slab. However, despite this change, they still offer higher liquidity than FDs.

Factors to Consider Before Investing in Target Maturity Mutual Funds

Here are some factors you should consider before investing in target maturity mutual funds -

1. No guaranteed returns: Return-based predictability holds only if you hold onto the fund until the maturity date. Redeeming the fund early will expose you to interest rate-related risks. Thus, you may receive returns lower than your expectations. 
2. Lower upside potential: Target maturity mutual funds mainly invest in low-risk, high-quality Government securities. Hence, returns may be lower than those of equity funds. They are more inclined toward stability, without blindly pursuing aggressive growth.
3. Syncing your investment horizon: A target-maturity mutual fund may only succeed if you align your investment horizon with its maturity date. If you want the money early, the fund's value may be affected by market volatility. 

Major Advantages of Investing in Target Maturity Mutual Funds

Some of the key advantages of investing in target maturity mutual funds include -

• You can benefit from investments such as SDLs and Government securities with higher credit quality. 
• The credit risks of these funds are lower, owing to their portfolios of highly rated instruments.
• The fixed maturity structure helps you sync your investments with particular financial goals.
• You can also benefit from lower expense ratios than those of actively managed funds.
• Holding securities to maturity reduces your interest rate risk, thereby ensuring more predictable, stable returns.

Risks Involved When Investing in Target Maturity Mutual Funds

Some of the key risks of investing in target maturity mutual funds include the following:

• Target maturity mutual funds do not have a historical track record. Although they may offer higher returns than many other bonds, they lack a performance history. You cannot always understand how the fund has performed in the past or its overall consistency.
• There are risks associated with an early exit, i.e., if you do not hold onto your funds until maturity. This may adversely affect your investment due to movements in interest rates. Hence, even though the funds are open-ended and you can exit when you wish, there are risks arising from interest rate shifts.
• Target-maturity mutual funds offer less flexibility than fund managers. It is not possible to invest in instruments or companies with varying cap sizes, and so on. There is negligible scope to adjust your portfolio, which means you may miss potential opportunities. 

Taxation of Target Maturity Mutual Funds

Target-maturity mutual funds are treated as debt funds in India. Hence, any gains you earn after 1st April, 2023, will be perceived as short-term capital gains. They are taxed as per your applicable income tax slab, without any consideration for the holding period. 

Earlier, LTCG (long-term capital gains) on investments with holding periods beyond 3 years was taxed at 20% (post-indexation). However, this benefit has now been eliminated for newer investments. Any payouts from the income distribution cum capital withdrawal (IDCW) will be added to your income and taxed as per the slab rate.