Debt Mutual Funds score over traditional savings

Have you recently come across a situation where, one of your old investments came up for renewal which had earned you a decent rate of interest but the renewal rate of interest is so low, it made you feel bad and really contemplate whether to renew or not? Don’t worry, you are not the only one facing this, there are many others, who have traditionally invested in such fixed rate saving schemes/deposits and are now facing a similar situation as you. There are also those who saved in various savings schemes which committed a specific rate of return, which are now lowered year after year.

These lower interest rates would mean different things to different segments of people. While existing and potential borrowers are delighted to see interest rate getting lower, investors in fixed income instruments area worried a lot for obvious reasons. The worst suffered are senior citizens who depend largely on the interest from their fixed deposits and small savings.

Can an investor do something about the low and further lowering interest rate condition? Is there a way to use the falling interest rates scenario to one’s benefit? What most of us know is that falling interest rates lead to lower returns on most traditional saving avenues. But what most investors are not aware of is that there are fixed income investment avenues which give higher returns in a falling interest rates scenario

This means that there is an inverse relationship between returns and interest rates movement and these investments gain when interest rates come down. These are known as debt mutual funds. Debt mutual funds, as you may have heard, invest in various fixed income instruments like bank certificates of deposits (CDs), commercial papers (CPs), treasury bills, government bonds (G-Sec), corporate bonds/debentures, cash and call instruments, and so on.

Debt mutual funds are classified based on the category and tenure of the underlying investment instruments and one can choose a suitable category depending on one’s investment horizon, risk appetite and returns expectations. So how do debt mutual funds make money for the investors? When one invests in a debt mutual fund, they are allotted units as per the prevailing NAV (Net Asset Value) of the fund. Interest rate decline has a positive impact on the price of the instruments in the portfolio of the debt funds, thereby increasing the NAV of the fund.

Now, the same units held by the investor are worth more than what the investor first invested thus generating generous returns. With the interest rates reducing, the better performing debt funds are the ones holding instruments with a higher maturity. Hence debt fund investors are in a sweet spot and will continue to remain so till the interest rates continue to tread lower.

Changing times demand better adaptability to the new conditions. Why should this not be true for one’s investments? Be it in terms of liquidity, superior returns, professional management or tax benefits, debt mutual funds score over traditional savings avenues.

A more beneficial approach would be to consider debt mutual funds which enable to make the most of falling interest rate regime by providing tax efficient returns as well as regular income. Investor should however, consult their financial and/or tax advisors to ascertain whether mutual funds are suitable for them. After all, higher returns come with the possibility of higher risks.