A reader wants to know, “Which debt mutual funds are suitable for short-term and long-term goals?” A discussion. A related question is whether debt funds are still relevant as there is no tax advantage compared to fixed deposits.
Yes, debt funds are still relevant because they are necessary for rebalancing a portfolio. Also, unlike FDs, debt funds are not taxed each year. They are taxed only when we redeem and to the extent of the redemption.
Here is a list of suitable debt mutual fund categories for short-term and long-term goals
The goal here is only to include categories low in credit rating risk.
- Liquid funds: These may be used for short-term (< 5Y) and intermediate-term (<10Y) goals and also when a long-term goal nears its deadline. This will work well if you wish to accumulate the target corpus in debt gradually. Yes, it is a conservative choice, but not all investors know how to navigate debt funds.
- Money market funds: A bit riskier than liquid funds but a good choice to gradually accumulate the target corpus in debt.
- Arbitrage funds: A tax-efficient choice (since it is considered an equity fund) but will be a bit more volatile than a money market fund. It can be used for the same purpose as above. So all three choices are well suited for one-way “rebalancing”: permanent shifting funds from equity to debt. The goal here is to safeguard the corpus, and the rate of return is not a primary concern.
The funds mentioned below are better suited for two-way rebalancing (equity to debt and vice versa) but are significantly more volatile. They should only be used for long term goals (> 10Y). In addition, the three funds mentioned above may also be necessary as the goal deadline nears.
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- Corporate Bond Funds: These would be less volatile than gilt funds. They are also prone to credit risk. Also see: Can we use HDFC Corporate Bond Fund for long term goals?
- Gilt funds: Only investors who can go through years and years of poor performance followed by a sudden jump in returns (or vice versa can invest in these). Also, see How to choose a gilt mutual fund.
Dynamic bond funds are unnecessary. Almost all gilt funds are “dynamic” in nature. That is, the fund manager changes the average portfolio maturity based on bond market supply vs demand for long term bonds (aka duration play). Also see: Gilt funds vs Dynamic Bond Funds vs Corporate Bond Funds: Which is the better choice?
Tax-efficient long-term options
Debt-oriented hybrid funds such as Parag Parikh Dynamic Asset Allocation Fund can be used by those with the stomach to bear risks. And: Parag Parikh Dynamic Asset Allocation Fund vs Parag Parikh Conservative Hybrid Fund.
Also, see: Which mutual funds are still taxed at 20% with indexation benefits?
In summary, for goals around ten years or less, we recommend using money market funds or arbitrage funds for one-way rebalancing from equity to debt and systematic rebalancing. For much longer tenure goals, gilt or corporate bond funds can be considered for two-way rebalancing. PPF (if enough time is available) and money market funds or arbitrage funds can be used for one-way rebalancing and de-risking.