Why debt funds are not same as FDs

Harsha commented in one of my previous posts about not mentioning debt funds. I do not consider debt funds as a good investment option since there are lot of negatives attached to it then the gains. As mentioned by The Hindu a debt and gilt funds usually invest in long-term borrowings of the government or corporate issuers at fixed rates of interest. These funds earn their return from two avenues — the interest payments that they receive from bonds/gilts and the fluctuations in the market price of their holdings.

The most negative aspect of debt fund compared to FD is that the returns are not assured due to linking with markets. Even after taking this risk, there are no tax breaks. A flat divident distribution tax (around 14%) is applicable to the mutual fund house which obviously cuts it out of the investor money. The returns are also not spectacular and hovers around 6-7 % which post distribution tax comes out to be 5.9%.

Compare this with a bank FD say for a yearly tenure. The interest rate is 7-8%, which comes out to be 5.1% post tax for the highest tax bracet. It goes higher(even about 6.5%) for people in lower tax bracket. Thus the biggest dis-advantage is that despite the risky nature the returns are more or less same, then why an investor should take the additional risk. The only advantage is the liquidity since there are no entry or exit loads (the charge applied by fund house on pulling out the money).


2 comments:

  1. Hmm..This is true. What do you think about post office savings? Dont they generate higher returns than bank deposits.
    Are their cases where the principal of debt funds are not repayed?

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  2. why there is unfound fear attached to debt funds? well, let me try to correlate FD to debt fund.

    1. In my words, FD is a closed debt fund. (that means it is illiquid until maturity to realize the promised interest).

    2. let's consider a debt fund that invests only in money market (assume only in g-sec and t-bills), the returns will be closely equal to yield curve.
    And if you check yield curve, the returns are atleast 50-100 points better than prevailing FD rates and there are scores of funds that invest only in money market.

    3. In order to meet obligations in time, many companies depend on short term debt. Some go for long term debt, instead of diluting equity. CRISIL gives rating to companies having good financial history. These companies also issue bonds! many debt funds invest 20-30% in such bonds and rest remains in govt. backed G-secs. Out of the 20-30% money invested in a diversified market, there are remote chances of messing up, or in worst scenarios losing money. The idea is to make more money than yield curve. Now choice is left to you to read through the print to understand how your debt fund manager is allocating funds across. Most debt fund yield are today more than 10%

    3. Where a debt fund scores over FD is liquidity, one can enjoy good yieid over a very short time (say one month).

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