When on 24th March, the Govt announced a change in tax rules in debt funds and made their capital gains fully taxable, mood was gloomy among investors.
Many Investors have been planning to shift their SIPs in debt funds and move towards equity or hybrid funds. Some have already done so.
But, is this the right move? Should investments be done only on the basis of taxation?
I am of the firm view that debt funds are the integral part of the portfolio and must remain so even after somewhat adverse taxation on them. Here is my take in favour of continuation of investments in debt funds-
1) Long term wealth creation requires right asset allocation- Totally equity oriented portfolios are prone to deep fluctuations. We have seen the downfall of up to 60% in the stock market. Every now and then, the stock market goes down quite heavily. If your portfolio is only of equity funds, then such downfalls not only disturb any impending liquidity requirement, they create psychological havoc among most of the investors. The same investors who felt their risk profile is aggressive, become over sensitive to such downfalls. Having debt in the portfolio limits such downfall and in such a situation, investors could look up to the debt portion of the portfolio for liquidity needs.
2) Having debt puts you in pole position to capitalise the downfall in equities-When equity market goes down big and it does quite regularly, your debt component may play the most important role. See, the best way to benefit from the downfall is to invest in such times. So if you have a reasonable debt fund balance, you can switch some amount in equities just when it is the most profitable to do so. But if you don’t have debt balance or little balance, then such desirable action would not be possible.
3) Debt is a good hedge to equities- You may know that generally the equity market moves inversely to interest rates in the economy. So, in the era of higher interest rates, equities more often than not perform poorly. But higher interest rates benefit the debt investments because you buy securities that fetch higher interest. Thus, in such times, debt provides some momentum to your portfolio till the economy comes back to a lower interest rate regime.
4) Debt funds cannot be fully replaced with hybrid funds- Many advisors may argue that investors should opt for hybrid funds with at least 35% equity exposure as they have better taxation benefit than debt funds. But in my opinion hybrid funds cannot replace debt funds completely. You may want a certain section of the portfolio which is immune to any market fluctuations. Hybrid equity funds though may not experience similar downfall as equity funds, they still are subject to fluctuations to the extent of their equity allocation.
Debt funds must be the essential part of most of the portfolios. Don’t stop investing in debt funds if your financial planning demands exposure in them. Right asset allocation should not be sacrificed at the altar of taxation only.
Manoj Pandey
CFP
