Role of fixed income in your financial plan

Most investors associate mutual funds mainly with equity investments. While equity as an asset class has an important role to play in your financial plan, fixed income or debt also has an equally important role. Traditionally fixed income investments have been associated with bank deposits, Government small savings schemes etc. However, debt mutual funds are increasingly becoming popular among investors as versatile and tax efficient investment solutions.

Why do you need fixed income in your financial plan?

• Financial goals: We have different financial goals for different stages of life. These goals can be short term, medium term or long term. While equity is mainly for long term goals, fixed income provides solutions for short, medium and long term goals.


• Lower risk: Different investors have different risk appetites, e.g. retirees will have lower risk appetite compared to a young investor. Fixed income as an asset class has much lower risks compared to equity and is suitable for investors with low to moderate risk appetites.


• Regular income: Some investors e.g. retirees may need regular income from their investments. There can be other situations in life when you need income from your investments, e.g. taking a sabbatical from work to pursue higher studies, supporting your children when they are in college etc. Fixed income is the ideal investment solution if you need regular income.


• Diversification through asset allocation: Diversification will enable you to take the optimum amount of risk as per your risk appetite. Asset allocation is essential for risk diversification and at the same time provides adequate returns to help you meet your financial goals. A mix of fixed income and equity in your investment portfolio is required for asset allocation.


• Liquidity: Emergencies can arise in any stage of life. You should have a contingency fund which can be easily converted into cash for emergencies like sudden loss of employment, unexpected large expense etc. High liquidity is also required for your short term goals as your cannot take high risks with such investments. Fixed income will be required for your liquidity needs e.g. contingency planning, short term goals etc.

Debt funds for financial planning

Even though mutual funds have gained a lot of popularity among retail investors over the last 20 years, vast majority of the retail investors still rely on traditional investment. However, investors should note that there are a number of reasons why they can consider debt mutual funds for their fixed income investment needs.

• Debt funds have potential of giving returns: Debt funds invest in debt and money market securities whose yields are usually good. However, debt funds are subject to interest rate and credit risks. Investors should invest in the appropriate schemes according to their risk profiles. Investors should consult with their financial advisors if required.


• Debt funds are tax efficient over long investment tenures (3+ years): While capital gains from debt funds held for less than 3 years are taxed as per the income tax rate of the investor, capital gains from investments held for more than 3 years are taxed at 20% after allowing for indexation benefits.


• Debt funds are highly liquid: There is no lock-in period in open ended debt funds. Please note that some schemes may charge exit load for partial or full redemptions within the exit load period. Please read the scheme information document carefully before investing.

Conclusion

Financial planning is not just about retirement planning or wealth creation. You need to have plans for different short term, medium term and long term goals. In this blog post, we have discussed why you need to have fixed income investments for your comprehensive financial plan. Debt funds provide a whole spectrum of solution for different investment needs. Investors should consider debt funds as versatile and tax efficient investment options. Investors should discuss with their financial advisors about how debt funds can be suitable for their different investment needs.

Past performance may or may not be sustained in the future.