SIP in Debt Mutual Funds

SIP in Debt Mutual Funds

When it comes to long term financial goals, SIP is an ideal mode of investment. Though SIP is popular among retail investors throughout the country, the misconception that SIP is a type of investment still continues. The risk of your investment largely depends on the underlying asset class, which can be equity fund, debt fund, etc; irrespective of whether you invest through SIP or in a lump sum.

SIP returns are highly dependent on the asset class

A lot of investors confuse SIP with equity mutual funds. Whether you investing in a lump sum or through a SIP, you need to have a moderately-high to high-risk appetite if you want to invest in equity mutual funds. To date, a lot of investors believe in how SIPs have low risk, and how rarely do they give negative returns. In fact, if you look at SIP returns across the category of equity funds, for example, large or multi-caps, and even midcaps and small caps: you will realize that most schemes have given a negative return over the last few years.

Thus, it can be stated with confidence that if you do not have a high-risk appetite, it is safer to invest in debt mutual funds, which have considerably lower risks as compared to equity funds.

SIP in debt mutual funds

Many investors would like to believe that lump sum investments are best suited for debt mutual funds. However, you can also invest in the same through a SIP. This, however, should happen in the following cases:

- You want to invest in a disciplined manner for your long term financial objectives from your regular savings. 

- You have some long investment tenures, and you want to take advantage of the power of compounding. Compounding is nothing but interest earned over interest, which can create large amounts of wealth in a long investment horizon. 

- You wish to take advantage of Rupee Cost Averaging. Since debt funds are market-linked financial instruments, their prices may fluctuate over time depending on the price sensitivity of the underlying asset. SIPs enable you to buy units at different price points and then average your cost of purchase.

How do SIPs in debt mutual funds create wealth?

While the wealth creation potential of equity funds is known to all, debt mutual funds can also create wealth for investors in the longer run. 

Debt funds invest in debt and money market instruments such as certificates of deposits, commercial papers, non-convertible debentures, Government Securities, Treasury Bills, etc. The yields of these instruments are much higher than the bank FD interest rates of many of these similar maturities. 

SIPs versus bank recurring deposits

Bank recurring deposits are a systematic investment plan in fixed deposits in banks. These will earn you interest at the rate which applies to the FD. Over the last ten years, bank RDs have given a 7.3% average annualized return. 

The SIP returns of a ten year Sovereign Bond Index and Corporate Bond Index were, however, able to beat the returns on a bank RD. 

Looking for good debt funds in the present economic environment

The coronavirus pandemic has forced the government to take some really stringent measures. These include the imposition of a total lockdown to prevent, or at least slowdown, the spread of the virus among the general masses. It is obvious that this will have far-flung consequences on the country, including a severe slowdown in many sectors. A severe recession in the global economy is sure to take place. And amid such scenarios, credit risk has become an important factor. This is because several companies now face the challenge of servicing their debt obligations. Investors, therefore, need to be aware of the credit risks, before making any investment decision. 

The SBI Corporate Bond Fund and SBI Banking & PSU Fund both are associated with low credit risk and have decently good performance track records. These two funds are therefore good investment options in the current economic situation.

SBI Corporate Debt Fund

SEBI has made it mandatory for corporate bond funds to invest at least eighty percent of their total assets in the highest-rated instruments. The SBI Corporate Bond Fund has 82% of its assets in AAA-rated instruments, followed by 15% in Government Securities and the remaining 3% in cash and cash equivalents. Thus, the credit quality of the scheme is high.

Additionally, the yield to maturity of the portfolio stands at 6.65%. as per data, the SBI Corporate Bond Fund has outperformed PPF in SIP returns, by giving returns of over 10.02% XIRR. 

SBI Banking and PSU Fund

SEBI has also made it mandatory for all Banking & PSU funds to invest at least 80% of their total assets in debt instruments that are issued by banks, public sector undertakings, and other public sector financial institutions. Moreover, the credit quality of such instruments is usually high because PSUs enjoy quasi-sovereign status. Additionally, banks are regulated by the RBI and are therefore seen as low risk, despite there being some one-off credit-related events, such as in the case of Yes Bank.

The SBI Banking and PSU Fund has 74% of its assets in AAA / A1+ rated instruments, followed by 9% in AA. The rest 17% is invested in Government Securities and cash equivalents, which have no credit risk. It is clear how the credit quality of this scheme is also high. 

The yield to maturity of the portfolio stands at 6.6%. even this SBI MF debt scheme managed to outperform PPF in SIP returns, by giving returns of over 9.50% XIRR

The Tax advantage offered by fixed-income funds

Though this concept of SIP in fixed income funds might be comparatively new to many investors, recurring deposits in the bank is essentially a kind of a SIP in fixed income. 

The Interest that is paid by bank recurring deposits is fully taxable, in accordance with the income tax rate of the investor. All Capital gains that have been made in fixed income funds which are held for more than 3 years are taxed at a 20% rate, after allowing for indexation benefits. These Indexation benefits can substantially reduce the tax obligations of investors that fall in the higher tax brackets. Furthermore, while the RD interest is taxable during the tenure of the investment itself, debt funds are taxed on the capital gains earned only on redemptions. However, the dividends that are paid by debt funds are added to one’s income and are then taxed according to the respective income tax rate.

All in all, SIP in debt mutual funds can also be a good investment for those investors who have moderately conservative to moderate risk appetite. Similar to SIPs in equity mutual funds, you will need to have long investment tenures and also hold a strong and disciplined approach.