Diversify your investments between different investment styles
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I had invested Rs13,500 on 25 February 2014 in a fixed maturity plan (FMP), which matured on 13 March 2017 and received Rs17,251.25. The gain was Rs3,751. As this was a debt investment, I need to pay tax on the gain. How much tax will I have to pay, with or without indexation? I want to invest this amount in other debt schemes but not in a closed-end scheme. I can remain invested for long but want liquidity in case of an emergency. Currently I am invested in Birla Sun Life Dynamic Bond Fund and ICICI Prudential Long Term Fund. Like in equity funds, do we need to spread our investments in debt funds as well?
If an investment in a debt fund is held for 3 or more years, any gains accruing from it would be treated as long term capital gains and the taxpayer would be able to get the indexation benefit on the cost of the investment (which will lower the amount of taxable gains). In your case, your fixed term plan matured a little after 3 years and hence it qualifies for such a benefit. Taking the cost inflation index for 2013-14 (939), which is the financial year of your purchase and the index for 2016-17 (1125), which is the year of sale, your indexed cost would be Rs16,174 and the taxable profit Rs1,077 (even though your overall profit is Rs3,751). Applying a tax rate of 23.69% (20% capital gains tax and 3.69% of cess), your capital gains tax on this FMP will be Rs255.
With respect to your next question on investing the maturity proceeds in debt funds – yes, it is important to spread your investments in debt funds between multiple investment styles. When it comes to debt funds, apart from distinctions regarding the duration of their holdings periods—short term, medium term, and long term—they can also be distinguished is by their strategy.
Some funds follow a duration strategy: they take interest rate calls in building their portfolio. Other funds follow an accrual strategy, where they predominantly buy and hold instruments and deliver returns from the coupon rate from these instruments. It would be prudent for an investor to have a mix of both these strategies in their debt fund portfolio.
For example, both the dynamic bond funds you are currently invested in, have a duration strategy—they take interest rate calls and hence have interest rate risk. You need to also hold some funds that have an accrual strategy. This would diversify your holdings. A short-term fund such as HDFC Short Term (minimum period of 2 years) would be an ideal diversifier other than the dynamic bond funds that you hold.
Srikanth Meenakshi is co-founder and COO, FundsIndia.com.
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