Mutual Funds have emerged as popular investment option in India due to their various benefits including paperless transactions, transparency and high ROI. The last benefit has in many cases has gained prominence only recently as interest rates of some of the “safe” government-backed/bank-guaranteed investment options such as bank fixed deposits, post office term deposits, PPF, EPF, etc. have been slashing their interest rates such that they are hardly able to keep pace with rising inflation levels. However, many prospective investors still shy away from investing in mutual funds as they have a lingering fear that their principal investment will be at risk for the entire time they choose to remain invested. In case of low risk tolerance investors, there is the option of investing in the relatively low risk debt mutual funds such as the ones launched by HDFC Mutual Fund AMC, Axis Mutual Fund AMC, Reliance Mutual Fund AMC and others.
Types of Mutual Funds
Mutual funds as per the definition refer to a pool of money that has been collected from investors for the purpose of being invested. Depending on the type of investment a mutual fund makes, they are classified into 3 key categories – equity, debt and hybrid funds. In equity funds, the key area of investment is company equity i.e. shares of companies listed on the stock exchange. In the case of debt mutual funds, their investment focus is on various types of debt papers including fixed deposits, government bonds/securities, corporate debentures/bonds, etc. which are relatively low-risk investments and can provide constant returns. The short version of hybrid funds definition is that they combine the best features of both debt and equity mutual funds. Debt Fund Subtypes The following are the common subtypes of debt mutual funds and examples of these funds from HDFC Mutual Fund AMC:
• Gilt Funds: These funds are invested mainly in government securities, which have zero risks of default but a small degree of interest rate risk as per changing market conditions. Example – HDFC Gilt Fund – Long-term Plan.
• Income Funds: The focus here is to generate consistent returns in the short to medium term. The key investment avenues, in this case, include government securities, corporate debentures, and bonds. Examples include HDFC Regular Savings Fund.
• Monthly Income Plans: The majority of investment is in debt instruments, while a minority is invested in equities such that consistent returns are maintained along with an acceptable degree of capital appreciation. The monthly income, in this case, is in the form of dividends that may be declared from time to time. Examples include the HDFC Mutual Fund Monthly Income Plan – Long Term Plan.
• Short Term Plans: These are among the lowest risk invest options available as they have a short investment horizon between 3 to 6 months. Investment areas include corporate debt, commercial papers, certificate of deposits, etc. A notable example is HDFC Mutual Fund High-Interest Fund – Short Term Plan.
• Liquid Plans: Commonly referred to as money market schemes, there are ideal investment options if an investor interest to park surplus funds for a very short period such as days or weeks. Liquid funds such as HDFC Cash Management Plan – Savings Plan invest in certificate of deposits, commercial papers, inter-bank call money market, Treasury Bills, etc.
Taxation Rules of Debt Funds
Debt funds of all types are subject to capital gains taxation rules depending on the number of months between allocation and redemption/switching of the units of the scheme that were allocated. Short term capital gains are applicable in case the debt mutual fund units are redeemed or switched before completion of 36 months from date to allotment. In this case, the capital gains are added to the taxable income of the investor and taxed as per the applicable tax slab. In case the debt fund units have been held for a period exceeding 36 months from the date of allotment, long-term capital gains are applicable. In the case of long-term capital gains, the current tax rate is 20% with indexation.
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