I'm 35 and fall under 30% tax bracket. Should I invest Rs 10 lakh in debt mutual funds or listed bonds for 5 years?

I am 35 and earn an income of Rs 15 lakh. I fall under the 30 per cent tax bracket. I am a conservative investor and want to invest Rs 10 lakh in debt instruments. Should I invest this amount in debt mutual funds or listed bonds? I want to invest for 5 years. 

Reply by Ajinkya Kulkarni, Co-founder and CEO, Wint Wealth  

I would have liked to have understood your goal, expected returns, overall portfolio, and tax bracket to provide a more informed answer. Based on your information, I assume you have a moderate risk appetite and come under the highest tax bracket.   

Both debt mutual funds and corporate bonds are debt securities with some of their pros and cons.  

Investment in corporate bonds fetches two types of income—interest and capital gains. When you redeem bonds at maturity or sell them in the secondary market, the profit earned is considered a capital gain. While a bond's interest income is taxed at an individual's slab rate, capital gain taxation varies with the holding period. If a listed bond is held for less than 12 months, any gain from the sale is considered short-term capital gain (STCG). STCGs are taxed at the individual's slab rate. If held for over 12 months, the gain is considered a long-term capital gain (LTCG). LTCG is taxed at 10 per cent plus a surcharge. In your case, you can hold most good bonds till maturity. Hence, you would have to pay LTCG.  

There are many online platforms where you can purchase duly evaluated investment-grade senior secured corporate bonds providing 9-11 per cent periodic interest payment and repay the principal as per pre-decided timelines. Unlike debt mutual funds, these platforms do not charge any joining or asset management fee, thus providing a clear edge over debt mutual funds. A word of caution here: While the high returns on corporate bonds seem attractive, you must understand that these are not fixed deposits. These bonds entail both credit and interest risk. Therefore, assessing the issuer's credit quality is essential before investing. Diversifying your bond portfolio with securities from at least 5-6 issuers would be best. Some online bond platforms also offer securitized debt instruments (SDI), which are baskets of some handpicked bonds to provide better diversification without having to evaluate bonds from multiple issuing entities.  

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Debt mutual funds are suitable for investors who do not have a lumpsum amount, unlike you but want to build their debt portfolio gradually.  

After the last Union Budget, where indexation benefits on the sale of debt mutual funds were removed, these have no tax advantage over corporate bonds. Debt mutual funds also reduce the choice of underlying securities and expected returns. These funds primarily invest in Government securities (G-Secs), AAA, and AA-rated bonds and have their prescribed sectoral exposure limits. Thus, investors in debt mutual funds do not get exposure to high-interest-yielding bonds. A corporate bond, if held till maturity, fetches a pre-decided return. Returns of debt mutual funds show significant deviations because of interest rate movements, defaults, and macro-environment. Any buying and selling by the fund manager due to these factors affect investors' returns.  

Conclusion: As you see, bonds offer higher returns than bonds, but the portfolio would have a concentration risk and the additional effort to select the bonds from suitable issuers. On the other hand, debt mutual funds are well diversified, taken care of by experienced managers, charge their administrative fee as an expense ratio, and provide comparatively moderate returns. You can now take a call based on your risk appetite and return expectations. Bonds are for you if you can afford to take additional risks and expect slightly better, fixed returns over and above a good debt mutual fund. Otherwise, you can invest via a debt mutual fund. 

Views expressed by the investment expert are his/her own. E-mail us your investment queries at askmoneytoday@intoday.com. We will get your queries answered by our panel of experts.)  

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