Look beyond debt mutual funds, your options are plenty

Bank FDs can be convenient to manage and offer various options with quite high rate of interest

The recent changes in tax provisions on debt mutual funds brought to fore the various fixed income options available for investors in the market. It is also pertinent to see whether one should go beyond debt mutual funds and look at the alternatives when it comes to investing in debt products.

There are several choices for investors in the market and they need to consider each one of them in detail to see which product really fits into one’s scheme of things and which one can offer better value to them in terms of higher net return.

So, what are these products and how do they stand out in the market today?

Debt mutual funds: Till now, debt mutual funds were a preferred mode of investment for investors simply because their net rate of returns worked out higher compared with traditional fixed income products like bank fixed deposits or say corporate bonds.

There are now two areas where the returns on these debt mutual funds will be hit. The first is that the dividend option will see a higher net impact as the mode of calculating the dividend distribution tax (DDT) has been changed from net basis to gross basis. This will lead to a higher tax implication for individual investors and, hence, they would end up bearing a higher cost, which would be significant because the rate of DDT for debt funds is 25 per cent plus surcharge plus cess.

The other impact will be on the capital gain, as the distinction between long-term and short-term capital gains will be visible only after three years (which used to be one year till the budget) and this could mean that most of the gain on investments would end up being classified as short-term capital gain, leading to higher tax outgo.

Fixed deposits: Bank fixed deposits may appear more attractive now as the distinction between them and debt mutual funds have virtually disappeared. The entire interest earned on bank fixed deposits is taxable as income from other sources, and it will be no different in the case of debt mutual funds if the investment is short term in nature.

But bank fixed deposits can be better in the sense that it is convenient to manage them and they offer various options or choices with quite high rate of interest. These make them an option one cannot easily ignore. In fact, it would be prudent to include this product while planning your fixed income investment.

Tax-free bonds: One instrument that will become very popular in this situation is tax-free bond as the income earned on this product is tax-free in the hands of the investor. Even if the returns are slightly lower than those offered by debt funds and bank fixed deposits, the post-tax income should still work out higher. This is something investors should keep in mind.

One has to be aware that the biggest benefit of these bonds will be for those who fall in the highest tax bracket. Thus, one has to take into account his/her specific conditions, especially in terms of the tax impact before taking a call on which fixed income product to pick.

(The writer is the CA and certified financial planner)


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