Opt for Debt funds, optimize returns

Posted by Namita Gad on 21 Nov, 2017

Opt for Debt funds, optimize returns

Indian economy is flushed with cash after demonetization. Despite several investment options available, Indian households still opt to park their savings with banks. Earlier, we have read about how one can elevate returns through bank fixed deposits while not sacrificing liquidity. But with interest rates being slashed frequently, one should revisit their portfolio to take a few simple measures to improve post-tax returns.

No single product might suit the everyone’s palate. One should consider several criteria while selecting their preferred investment option: income, expected average returns, risk appetite, required liquidity, applicable tax bracket, size of portfolio and so on.

Let’s try to understand the below given alternatives. With each alternative, the rate of return improves significantly while also increasing the risk factor marginally.

  1. Savings Account

    • Interest Rate: 4% p.a.
    • Liquidity: Highest
    • Tax: Tax-free up to Rs.10,000 in a financial year and applicable tax slab above that
    • Risk meter: Low

  2. Fixed Deposits

    • Interest Rate: Have reduced to 6-7% p.a.
    • Liquidity: Highest (depending on bank; similar to Savings account)
    • Tax: Applicable tax slab as per income; so investors with highest tax slab earn less than 5% p.a. post tax
    • Risk meter: Low

  3. Mutual Funds (MF): MF companies are safe even though Indian masses are not comfortable with non-banking institutions managing their money. But one should explore Short Term Debt funds which primarily invest in fixed-income instruments with short-term maturities to diversify their portfolio.

    • Interest Rate: 7-10% p.a.
    • Liquidity: Moderate; Fund houses usually take 1-3 days to process redemptions
    • Tax: Treated as Capital gains; taxed at 20% with indexation if held for at least 36 months; as per applicable slabs if held for a lesser duration
    • Risk meter: Moderate

  4. Arbitrage Funds (AF)

    • Interest Rate: 6-10% p.a.
    • Liquidity: Moderate
    • Tax: More tax-efficient than short-term debt funds, taxed at 15% if redeemed within a year; else tax-free
    • Risk meter: Moderate

If observed closely, each option gives a better post-tax returns than the previous one with moderately increasing risk factor. Look closely for the exit loads in case of mutual fund investments and always calculate post-tax returns before concluding the best option for you.