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POSTED BY ON November 17, 2010 11:22 am COMMENTS (3)
question from a reader on mail
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I have a question for you, which I really need to understand. It might seem very stupid to you, but I really don’t understand the principle behind investing in Debt funds. Why invest in debt funds, when so many FD schemes and PPFs etc are available? I was just going through the long-term returns of some of the Debt funds available in the market and found them comparable (in some cases even lower) to the present FD rates. Moreover, there is an added advantage of the security factor in case of FDs. So what is the real point in investing in Debt funds for a long-term basis?
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In case of decreasing interest rate scenario, the yield and returns from long term debt plans can actually almost double, which is not possible in FD and PPF.
Also, if you note, the interest rate on PPF has been steadily decreasing. It was initially 12% per annum, dropped to 11%, then 9.5% and is now 8%. This rate of interest is fixed by the government and there is nothing you can do about it. Nothing prevents the govt to decrease it further down in a few years.
Ramesh
thats a good point 🙂 . So investing in debt funds makes sure we get market linked returns (not equity market linked but debt market linked) , and not depend on just govt 🙂
Manish
my answer
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Ok , so first thing is PPF , PPF is not liquid , so if you want to invest in PPF , your money gets locked for several years and you cant take money out in short term incase you need it , so it provides security , but at cost of liquidity .
So incase you want to have security as well as liquidity , you can invest in debt funds or FD . Howeve even in FD , if you take money out before the maturity , your returns are vanished overall and you get almost very less returns or no return .
But thats not the point of investing in debt funds ,apart from returns , debt funds are tax efficient which makes thier returns higher than FD many times . FD interest is just added to your income and taxed , so if you are in 30% bracked , you pay 30% return on interst .
However if you invest in debt fund , you pay just 20% tax after applying Indexation or just 10% tax without indexation , so it benefits investors in higher bracket .
However for this extra thing you get in Debt funds, it comes at the cost of some risks which are liquidity risks and bad returns from debt funds . So overall debt funds have their own plus and minus also .
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