Despite removal of tax benefit, debt MFs are still attractive investments; Dhirendra Kumar explains why

In the case of mutual fund, one does not get any assurance, but there is an advantage. Assuming you made a Rs 1 lakh deposit in a bank and 7%, 8% interest income, that was taxable income. If you invested Rs 1 lakh in a mutual fund and you kept holding it for three years, it was considered your capital gain. It was not considered an income. And because it was capital gain, it was adjusted for inflation. The cost inflation index is announced by the government in every Budget. It was adjusted for that.

So only whatever was your appreciation, whatever was your return over and above the inflation, was your taxable gains. Now, that benefit is gone. Now, all that you earn from your bank deposit or your mutual fund will be taxable, will be considered as your income, and it will be taxed according to your marginal rate of taxation.

If you happen to be a person who is not supposed to pay taxes, you remain tax-free. If you happen to be a person who pays 10% or 20% you pay only that much, that percentage. We have been used to this advantageous taxation treatment of the debt fund. Now that advantageous tax treatment is gone.

But still, debt funds remain attractive because you can plan things much better with them. If you invest in a debt fund and hold it for 10 years, you do not pay any taxes for the first 10 years. It is a great tax deferral vehicle. It also allows you diversification. Besides that, the money is always on demand. You can get your money back in 24 hours, 48 hours, any time, on demand. This money is on demand, unlike deposits and bonds.It is now all about becoming a smart investor and planning your investments smartly. After this particular change, which are the fixed income instrument options that are more attractive now? What parameters would you apply in case we want to compare all these investment instruments?
Fixed income funds are extraordinarily attractive because of their liquidity. When you open a PPF account, you are stuck for 15 years. When you do a post office MIP, it is different. Your money is stuck and you are getting your income. In the case of a mutual fund, you get all the flexibility. You can set up your SWP. In case of an emergency, you can pull your money out anytime.

So it is the liquidity which provides you a great advantage. I think every investor must have this as a part of his allocation. There are many long-term fixed income investors in India. Long-term fixed income investors should go with a vehicle which is the safest because the need for liquidity is not there.

But for every investor, 10% of the money should be in fixed income funds simply because if you want to rebalance, assuming the market goes down and you have chosen to have 50% into equity, have 10% of that in fixed income fund because that is the only money which you can get in 24 hours. And if you want to invest your money into an equity fund at an inopportune time on a special opportunity for rebalancing your portfolio, you can do that. So I think there is still a case for it.

Anyway, these vehicles are very attractive or they are a useful vehicle for companies to park their surplus in the liquid fund, the money market fund, and also the short-term debt funds of many kinds. These funds are useful even for investors.

Investors should steer clear of the sophisticated category that has been created, the 16 kinds of funds because most people do not understand and they get an unpleasant surprise because many of these funds are exposed to interest rate risk. When interest rates go up, these bond funds go down in value and individual investors are unable to reconcile with that decline in value. Besides that, there is a credit risk, which, however, is fairly well managed in the case of the mutual funds. Individual investors should consider short-term debt funds. For the rest of the investors, life is as usual.

Will insurance insurance investment products and bank FDs gain traction and become more attractive now?
It could be a tactical advantage for them in the short run in terms of noise or creating a sales pitch. But it is very important for any thoughtful investor to be planning all these things carefully; planning the investments and withdrawals in terms of what is right for you, what is best for you, what will optimize your return, what suits your temperament and what is also tax efficient because if you are not conscious of that, I do not think it is going to make a difference in the long run.