Debt mutual fund Archives - Hum Fauji Initiatives

Col Sher Khan is a go-getter infantry officer, known for his professional acumen and is a sought-after party animal. He and his family live life to the full. His only Achilles Heel is finance. He routinely has a large amount – anything from Rs 75,000 to even 2-3 Lakhs lying in his savings bank account at any given time, earning 4% savings bank interest. And just because it was lying there, unimportant expenditures would come up and suddenly become urgent and the most important ones to be done then and there. He was fully aware that bank interest is fully taxable and he being in 30% bracket, it practically earned him a mere 4% – (30% of 4%) = 4% – 1.2% = 2.8% interest. He wanted to do something about it but didn’t know what and how.

That’s the time he got introduced to Liquid Funds by a friend. He suddenly realised that he could earn double the interest, have the money safely tucked away so as not to be ‘very easily’ available but still be available at one working day notice through sms, phone call or net login. He started it and found it reduced unnecessary expenditure while not affecting his life-style in any way.

So what are Liquid Funds? Liquid fund is a category of debt mutual fund which invests primarily in extremely safe instruments like certificate of deposits of the banks,government treasury bills, commercial papers of highly rated companies etc. They have no lock-in period and withdrawals from them are processed within 24 hours on business days. The cut-off time on withdrawal is generally 2 pm on business days. It means if you place a redemption request by 2 pm on a business day, the funds will be credited to your bank account on the next business day by 10 am. Liquid funds have no entry load, exit loads and like all mutual funds, have no concept of TDS (Tax Deduction at Source) unlike the bank savings bank or FDs. This implies that you can put in any amount any time, and withdraw any time while the rest of it lying in the fund keeps earning its good interest.

Liquid funds are among the best investment options for the short term during a high inflation environment. Their taxation is as per your tax slab but double the savings bank returns ensure a large additional surplus returns to you. During the past years, some liquid funds have even offered higher returns than bank fixed deposits, which levy a penalty on premature withdrawal.Many fund houses give the option of transacting (investing and withdrawal using your bank account) in them through sms and phone from registered mobile number apart from the internet, thus bringing your money to your literal fingertips! One fund house even gives an ATM card for withdrawing up to about Rs 50,000 from bank ATMs.

Finally, what should you use your Liquid Fund for?

Surplus money which earns practically nothing, lying in your savings bank account.
Money you leave in bank account catering for EMIs or instalments over next few months.
Sales proceeds of your previous house/flat till you invest in new one.
Funds created for your child’s education /marriage till you use it.
Lump sum amount lying in your bank account which you may be required any time
Large amount of money lying idle over long weekends whether your own or the company’s. Example: Rs 1 Cr kept for one day will earn about Rs. 2200 per day as per current Liquid Fund returns. This means, this happening over weekends throughout the year in your company will earn you Rs 2,28,000 (salary of one person?).

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Last of our knowledge series on Debt Mutual Funds below gives out what can you expect from Debt MFs. As you will see, compared to other fixed income products like bank FDs, Post Office schemes, Senior Citizen Savings Scheme etc, Debt MFs are poised to give better returns, are much more tax-efficient, and have much better liquidity and flexibility. Thus, they can be your flagship product for the part of the portfolio where you are looking for safe and tax-efficient wealth creation.

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What kind of returns do Debt Funds offer?

Debt funds offer two kinds of income:

Dividends &
Capital gains

Dividends: Debt funds receive interest on the debt securities invested by the fund. This interest can be distributed to the investors of the debt fund as dividends. Dividend distribution is however subject to availability of distributable surplus and approval from the Trustees of the Mutual Fund.

Capital gains: As stated earlier, debt fund managers trade in debt securities in the debt segment in order to earn profits. This gain or loss is typically reflected in the NAV movement of the debt scheme which would include the accrued interest on the securities too. For instance, let’s say an investor invests in a debt scheme at an NAV of say, Rs 12; when he wants to redeem, if the NAV is say, Rs 13.5, he would earn a capital gain of Rs 1.5 per unit (Rs 13.5 minus Rs 12).

What about tax? Do I need to pay tax on my debt mutual funds?

Tax on dividend income:

Dividend income that you receive from your debt fund is tax-free in your hands. However, the mutual fund has to pay tax (called Dividend Distribution Tax) at the rate of 28.325% for individuals before distributing dividend. In other words, you get dividend after payment of this tax.

Tax on capital gains:

Tax on capital gains in case of debt funds depends on how long you stay invested in the fund for. If you stay invested for less than a year, the capital gain gets added to your other income and is taxed according to rate applicable to your total income. For instance, if you are in the tax bracket of 20% and you earn a capital gain of Rs 5,000 on redemption of your debt scheme, you will pay tax of Rs 1,000 (20% of Rs 5,000).

If you stay invested for more than a year, the capital gains that you earn from your debt funds are taxed at a lower rate of 10% without indexation or 20% with indexation (the government publishes a cost inflation index table each year for this purpose), whichever is lower. Indexation helps you increase the cost of your investment to account for inflation. So for example, if you have invested in a debt scheme at Rs 10 and redeemed after a year at Rs 20, you either pay 10% tax on Rs 10 (Rs 20 minus Rs 10) or 20% tax on Rs 9.2 (Rs 20 minus Rs 10.8 – assuming inflation @8%). You pay tax on the lower of the two, that is, 10% of Rs 10, which is Re 1 or 20% of Rs 9.2, which is Rs1.84. So you pay Re 1 per unit as tax.

My bank deposits offer me the ‘cumulative’ facility where my interest is reinvested and given to me along with my deposit amount when the deposit matures. Do mutual funds offer something similar?

Mutual funds offer three ways of receiving income:

Dividend payout: Here, you instruct the mutual fund to pay you the dividends when they are declared. In other words, the dividend amount is credited to your bank account.

Dividend reinvestment: Here, you instruct the mutual fund to reinvest the dividend due to you back into the scheme. In this case, the reinvestment into the scheme is done at the NAV at the time of the dividend declaration.

Growth: Here, you instruct the mutual fund not to give you the dividend; instead, the dividend is retained within the scheme and the NAV of the scheme accordingly rises. Hence, instead of dividend, you get capital appreciation. This option is similar to the ‘cumulative’ option offered in bank deposits

Col (retd) Sanjeev Govila

CEO, Hum Fauji Initiatives

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Tag: Debt mutual fund

Liquid Funds- 4% more Interest without you doing anything….

What returns to expect from Debt Mutual Funds