Who Should Invest in Debt Funds and Tax Implications

If someone asks who should include carbs, protein, or vitamins in their diet, what would you reply? Simple, you would say everyone! Every person needs all types of nutrients but the proportion may vary depending on age, gender, and physical requirements.

The same principle applies to your investments. You must diversify your portfolio and include different asset classes, such as equity, debt funds, gold, real estate, and other products. However, the percentage holding may vary depending on your risk appetite, investment horizon, and financial goals.

While debt funds must be a part of every investor’s portfolio, here are some categories of investors who may benefit more:

Novice Investors

If you have not invested in mutual funds, starting with debt funds is advisable. It provides investment stability and is less risky when compared to equity funds. Investors who want to move from traditional investments like fixed or recurring deposits may choose these types of funds to earn a potentially higher return.

Equity Investors

Equity investors generally have a long-term investment horizon to ride through the short-term market volatility. If you are an equity investor, not including debt mutual funds is not advisable. You can opt for these funds to park your money in the short term if the equity markets are not favourable for immediate investments. Debt funds are also a good option to meet short-term financial goals while diversifying your portfolio.

Risk-Averse Investors

If you do not want to assume a higher investment risk, debt funds may be a good option to meet your financial objectives. These funds may be effectively used to meet short-term and long-term goals, such as buying a car, children’s education, and retirement planning.

Senior Investors

Retirement is an important life stage and requires proper planning to ensure financial stability in this phase of your life. Post-retirement, investors aim for stable returns to sustain their lifestyles and meet regular expenses. Debt funds are an excellent way to earn regular and stable returns to meet these objectives.

Experienced Investors

In the later stages of your life, after your goals are chalked out and you have been investing for some time, you may include debt funds to balance the risks associated with other instruments, such as gold and real estate. You may choose these funds to stabilize your portfolio and also park a lump sum as you start a systematic transfer plan to equity funds.

Tax Implications

Prior to 1st April 2023

• Short-Term Capital Gains: When the investment was sold within 36 months, short-term capital gains were added to your income and taxed as per your income tax slab.
• Long-term Capital Gains: When you held the investments for more than 36 months, long-term capital gains were taxed at 20% with an indexation benefit.

Post 1st April 2023

• Short-term and long-term capital gains on debt funds are added to your income and taxed as per the applicable income tax slab.

Example

Assume you invested INR 10 lakhs on 1st April 2020 and sold the units for INR 20 lakhs on 31st March 2023. The tax calculation is as below:

Assume you sold the investment on 31st March 2024 for INR 20,00,000. The tax calculation is as below:

Taxation before and after the amendment

Tax Slab	Before	After
10%	1,80,067	1,00,000
20%	1,80,067	2,00,000
30%	1,80,067	3,00,000

The changes to the taxation of debt funds adversely impact investors. However, there are several benefits to continue investing in these schemes:

• Capital gains tax is payable only when you exit your investments and no tax is applicable during the holding period
• Capital losses can be set off against debt fund gains or carried forward, which is not available if you invest in FDs
• Short-term capital loss can be set off against STCG or LTCG in the same financial year

Tax implications on debt funds may have changed; however, there are several ways to reduce your liability. Consult our experts to know more about debt fund investments.