Debt funds: Why we should not ignore the same?

Come to think of mutual funds, there is a perception that debt funds are for institutions and most individuals park money in schemes that invest bulk of the proceeds in equities. While it's not such a bad idea, it's always a risky proposition. To hedge against a slide in the stock markets, it's best to invest some proceeds of your capital in debt mutual funds.

Often the question that occurs in the mind of investors is: I can invest in bank fixed deposit. Why a debt mutual fund? The answer is simple - if you take into account taxes, you would realise that debt mutual funds are more tax efficient.

Interest earned on a bank deposit is added to your total income and taxed accordingly. For example, if you are in the 30 per cent tax bracket, then, 30 per cent of the interest earned on a bank fixed deposit would go towards payment of taxes, lowering your yield.

In case of debt mutual funds, you could opt for dividends distribution which is tax free in the hands of the investor. However, it's important to note that a Dividend Distribution Tax of 25 per cent is to be paid by the Asset Management Company and same is obviously recover from you, reducing the dividend payout.

The best part of a debt fund is that if you hold onto it for the long term (more than 1 year) the long-term capital gains tax without indexation is 10 per cent. This is certainly beneficial, if you are parking money in fixed deposits and are in the 30 per cent and 20 per cent tax bracket.

Debt funds are relatively safe, as they park their money in government securities and extremely safe corporate bonds. So, to hedge against equity risks, you might want to consider debt funds.