What are Fixed Income Mutual Funds – Definition, Taxation, and Examples
Equity funds can create wealth in the long run but are volatile and vulnerable to deep corrections in the short run. Hence, they are suitable only for people with a high-risk appetite and long investment horizon. Fixed income funds provide slow and steady returns. In the short and long term, fixed-income funds' volatility is lower than equity funds. Hence, debt funds are suitable for people with low to moderate risk appetite. This article focuses on what are fixed income mutual funds – Definition, taxation, and examples.
What are fixed income mutual funds?
A fixed income mutual fund invests its money in debt securities or fixed income securities such as treasury bills, Government bonds, state development loans (SDLs), corporate bonds, certificate of deposit (CD), commercial paper (CP), etc.
A fixed income mutual fund makes money in two ways: interest income and capital gain. Most fixed income securities pay interest either half-yearly or annually. The fixed income scheme receives interest income on the securities during the holding period. Fixed income schemes earn a steady stream of interest income on the securities.
Bond prices and interest rates have an inverse relationship. When market interest rates go down, the bond prices go up. In a falling interest rate scenario, if the fund manager decides to sell the bonds before maturity, they can make a capital gain.
The interest income and capital gain increase the scheme's net asset value (NAV).
Taxation of fixed income mutual funds
The taxation of fixed income mutual funds depends on the holding period.
Short-term capital gains (STCG) tax: If you redeem your fixed income mutual fund units within thirty-six months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) will be added to your overall income and taxed as per the income tax slab that you fall in.
- Long-term capital gains (LTCG) tax: If you redeem your fixed income mutual fund units after thirty-six months of purchase, the capital gain will be classified as long-term capital gain (LTCG). The long-term capital gain (LTCG) tax will be levied at 20% with indexation benefit and 10% without indexation.
Who should invest in fixed income mutual funds?
The following investors should invest in fixed income mutual funds:
Conservative to moderate risk appetite: If you are an investor with a conservative to moderate risk appetite (profile), you may consider investing in fixed income mutual funds. These mutual funds experience a lot less volatility than equity mutual funds. However, you need to understand that fixed income mutual funds can provide low to moderate returns. Sometimes, the returns from these schemes may not be able to beat inflation. If inflation is higher than the returns, it will result in negative returns. It means your money is losing purchasing power rather than earning returns.
Steady income flow: As an investor, if you are looking for an investment option that can give you regular returns, you may consider investing in fixed income mutual funds. These funds invest in debt securities that usually pay interest income half-yearly or annually. So, these funds can provide you with a stream of steady income.
Asset allocation: Asset allocation requires an investor to diversify into various asset classes such as equity, debt, gold, real estate, etc. As an investor, if you are looking to diversify beyond equity mutual funds, you may consider allocating the debt portion of your investment portfolio to fixed-income mutual funds. Equity can grow your investment portfolio and create wealth for you. When equity markets are falling sharply during volatile times, fixed income mutual funds will act as a shock absorber and cushion the fall. During such times, fixed-income securities will support your investment portfolio.
- Capital protection: As an investor, have you received a lumpsum amount and are still figuring out where to invest it for the long term? In such cases, you can park the lumpsum amount in a fixed income scheme such as a liquid fund or a money market fund. The objective of these funds is to protect capital. These funds offer low returns.
Investors invest in fixed income mutual funds for various reasons. Some of these include preserving capital, low risk, regular income, diversifying an investment portfolio, etc. Whatever is your reason for investing in fixed income mutual funds, you can always find the right fixed income mutual fund and accordingly invest in it.
To start investing in fixed income mutual funds as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started.