Flexible approach to debt funds

After retirement from service, I have received a lump sum from my employer. I have already invested 60 per cent of those funds in 9 per cent Senior Citizen's Scheme. I want to invest the balance amount in avenues where the rate of interest is 10 per cent or more. What are the options? As an ex-employee of bank as well as senior citizen I obtain interest at 9 per cent from my bank. Would it be worthwhile to invest in debt funds?

Asok Biswas

You have done well to invest a good portion of your retirement funds in Senior Citizen's scheme. While the scheme cannot boast of superior returns, it is among the safest and steadier return options available at present. Investment made in the scheme is also available for tax deduction under Section 80C of the Income Tax Act for the present.

The interest rate offered by your bank also appears attractive. You can consider a 1-2 year deposit in it. As for the rest of your funds, do not lock in to long-term bank deposits at the moment. Interest rates are expected to gradually ascend by the end of this year. Keep a look out for 2-3 year bank deposit rates of over 9 per cent. This may not happen in the next few months though.

That leaves you with the option of corporate fixed deposits and debt funds. If you are familiar with investing in corporate deposits, look for those with high credit rating and offering returns of at least 9 per cent.

The limitation in most of these fixed income options is that there would be no guarantee as to whether they would provide you inflation-beating returns. In other words, a faster rate of inflation could mean that the post tax income (interest income is taxable) from these options do not meet your cost of living.

Debt fund investing

Unless you have other sources of income from property and so on, you may have to take some exposure to debt funds that provide you superior returns.

The key advantage here is that debt funds are open-ended — which means that you can withdraw the money when ever you wish to. Redemption proceeds are typically received within three working days. This key benefit of liquidity is not available in your other deposit schemes. Besides, the dividend income is not taxed. However, there would be capital gains on sale of debt funds.

Some of the top debt funds have generated three-year returns of 11-12 per cent and even higher returns over a five-year period. The average, though, is as low as 7 per cent, effectively suggesting that there can be a wide variance in the performance of these funds, which are subject to interest rate risk and credit risk of the underlying security they invest in.

Unlike your fixed deposits, debt mutual funds are more actively managed and churned; reason why they are able to generate superior returns for slightly higher risk undertaken. But remember, the NAV of debt funds, too, can fall sharply.

We, therefore, suggest some debt funds, with a flexi-approach and some monthly income funds which would do the task of managing the interest rate cycle and credit risk for you.

Consider investing about 15-20 per cent of your retirement funds in HDFC MIP Long term, UTI Mahila Unit Scheme (through your spouse or daughter), Canara Robeco Income, Reliance MIP and Fortis Flexi Debt.

These are a combination of monthly income plans and income funds. Opt for the dividend payout scheme if you are risk averse and need some inflows.

Note that mutual funds do not guarantee regular dividends. Even as MIP options strive to give you regular dividends, they are not under any obligation to do so. Hence, do not look at debt funds as a monthly source of income.

They are best viewed as a supplement, with returns perhaps superior to deposits. If the funds you hold do not declare dividend regularly, consider selling some units once or twice a year, to cash out the profits.