Traditionally we have
been investing major part of our savings either in bank fixed deposits or
postal schemes. This clearly indicates our bias towards safety and security of
the principal amount over returns and liquidity when it comes to investment.
While investing majority of us do not care whether the accretion on such
investment is taxable or not. Even individuals who are in highest slab of 30%
tax rate also follow traditional investment pattern. Other preferred debt
instruments are PPF or traditional life insurance plans, but there are some
restrictions on investment in PPF and insurance as insurance is seen as a tax
saving avenue. You cannot deposit more than Rs. 1lakh in PPF account in one
name. Maximum deduction under income tax act is also available up to Rs. 1lakh
for PPF and insurance plans. PPF and insurance plans have their limitations and
therefore major chunk of investment goes into bank fixed deposit and postal
schemes. Most of the person investing in these do not bother to evaluate
whether post tax returns from all these avenues will beat inflation or not.
Nobody can certainly
deny the importance of safety but one has to always look for and evaluate other
options which are equally safe but can help you generate better returns or can
give tax advantage. Naturally it is
important to have debt in your overall investment portfolio but it should be
limited to certain percentage of your total assets depending on your age, time
horizon of your goal and your risk profile. Thumb rule says debt must
constitute minimum equal to one’s age in percentage terms but it is advisable
to allocate assets in debt depending on time horizon of your particular
financial goal. After finalising debt part you should also look at other
alternatives available in the market which can give you better post tax returns
compared to bank FDs and are equally safe. Mutual Funds’ FMP (Fixed Maturity
Plans) are better alternative for time horizon of around 13 months to 24
months. Income Funds and MIP funds are also better options if time horizon is 2
years or more. FMPs and Income fund invests 100% in debt products like
Government securities and corporate bonds whereas MIP funds invest 15 to 20% in
equity and balance in debt products. These funds not only give higher returns
compared to bank fixed deposits but are also tax efficient. Debt funds of
mutual fund always give better returns when interest rates fall. MIP fund gives
you added advantage of investing in equity when market moves up.
The important thing to
note that if these products give higher returns compared to traditional
products and are equally safe and more tax efficient than why they are not
popular among the common people. The lack of awareness among the common people
is the one of the reason behind this. Most of the people believe that mutual
fund means equity investment. It’s time to create awareness among the people
and make them understand that Mutual Funds offers both 100% debt to 100% equity
and also hybrid products with combination of equity and debt. The major reason,
according to me, why debt funds are not popular is that they are market related
and returns are not guaranteed and also higher charges levied in the debt
mutual fund. The higher charge of around 2% p.a. year on year reduces the
overall returns. SEBIs recent announcement will increase the total expense
ratio by another 45 to 50bps and reduces debt returns further. Is this hike
justified in debt products as the returns normally does not touch double figure.
The commission paid to distributors is also high in debt products compared to
equity schemes. Looking at all these facts SEBI must reconsider hike in debt
products and instead it should reduce the charges in debt funds to make debt
products more popular amongst the common investor.
The article first appeared at moneycontrol.com on 5th October'2012.
