4 Reasons Why Debt Funds Work Better Than Direct Bond Investments

Debt Funds Work Better Than Direct Bond Investments

In an important statement, the Reserve Bank of India made a key announcement related to retail investment. The RBI announced that investors could purchase government securities in a direct way. Nonetheless, you will discover many reasons why it makes more sense to invest in debt funds, rather than buy bonds from the market. The reasons explored here may convince you that investments in debt funds see you through to your financial goals successfully. 

1. Portfolio Diversification with Debt Funds

The aim of any serious investor should be the diversification of a financial portfolio. This is a key rule in the case of investing, and any seasoned investor will tell you to broaden the scope of your fund allocation. Investors normally underestimate the pros of diversification. However, time and time again, the fortunes of even bonds with AAA ratings, such as Dewan Housing Finance and Infrastructure Leasing & Financial Services,  can diminish. Worse still, such bonds may easily default in the  payment of timely interest and  the principal. A full blown crisis across promoter groups and several companies occurred before investors even realised that credit risks emerge from high yields.

This is where portfolio diversification enters the picture and helps. Nevertheless, in the event you buy direct bonds, it could be cumbersome to evaluate many issuers, although you may have moderately good sums, say Rs. 15 lakh, to deploy. Debt funds are beneficial in that they help you to diversify a portfolio. Typically, the allocation of any investor to an issuer is higher in a portfolio, relative to the allocation of a bond fund to that issuer. If there is a default, any loss to the bond fund is lower compared to the individual. An individual with a high net-worth can create a diversified bond portfolio with bonds issued by issuers of a high quality. However, individuals who are smaller investors are much better off when they invest in bond/debt funds and diversify a portfolio with a moderate investment size, as in mutual funds where small amounts may be accepted. 

2. Tax-Friendly Debt Funds 

If regular monthly income is not a priority for you, then you need not unnecessarily invest in bonds. If you do, you stand to incur a tax liability. When you file your income tax returns, the income you receive from bonds (in the form of interest) is taken as part of your income and taxed as per your income slab or bracket. 

Debt funds work in a better manner. You only have to pay tax if you happen to sell funds. If bond fund units are held for over three years, you incur  capital gains tax, levied at 20% after indexation. The burden of tax gets postponed and is, thus, effectively reduced. However, in case you fall within the low bracket of income tax, you can opt for bond investments directly. 

3. The Requirement of High Investment 

It may prove difficult for small investors to make investments in government securities or overnight bonds due to the sizes of larger lots. Corporate bonds, such as those rated AA and under, are quite complex to evaluate from a risk/return perspective. Moreover, these are rarely available for small investors in the markets of debt funds. 

In a scenario in which interest rates are fast falling, it pays for people to invest in lengthy-dated bonds issued by the government. Investors may consider liquid fund investments for the instant short term. Short duration funds are another possibility for the very short investment period. 

4. Liquidity is Better

Bond markets in India are far from liquid. Investors may be tempted to buy bonds with high interest rates. However, bonds with a high yield are rated lower and so, they are less liquid. This is a typical scenario. However, in the event that macroeconomic circumstances worsen, as they had during the global health crisis of the past two years, then bonds won’t swim, but sink. Bonds are not traded, generally, in the secondary markets, and even if they are, there exists a substantial discount to any bond’s fair value.

Investors in debt funds have liquidity which is assured at the net asset value. Although certain events at Franklin Templeton may have shaken several investors’ confidence in debt funds, well-managed funds that arise from reputed houses of mutual funds may still be worthy of investment.

Reinvestment is Easy

For the ease of getting periodic and regular payouts from interest, investors often hold fixed deposits and many bonds. Nonetheless, monitoring these on a frequent basis is a tedious task. In several instances, interest that is received in bank accounts lies there without the notice of investors. Many a time, it is spent, or gets deployed later,  for reasons like the small amount size or insufficient time. However, if you invest in debt funds, receipts are redeployed, and that too, in the best available opportunities.

Prudent Investment

With regard to risk, debt funds come the closest to conventional fixed deposits. The main goal of debt funds is to let investors have stable income throughout their horizon of investment. Choosing a timeline that is aligned with a debt fund is imperative for any investor who wishes to gain from a debt fund. Finding out about different debt funds is easy, and you can do this online, through a fund house, or any brokerage. 

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