As a result, investors are now more willing to consider products they have probably not invested in before. Various categories of mutual funds—which come with in-built advantages such as asset class choices and combinations, diversified portfolios and professional management—are good alternatives. They are especially useful for do-it-yourself investors. While equity mutual funds have become the default option for the equity allocation in most retail portfolios, the other categories of mutual funds do not get the same attention.
Here are some mutual fund categories you can use to replace traditional products for different needs.
For short-term balances: Investors hold money in their savings bank account either to meet immediate expenses or park their savings until they are able to invest them. With interest rates as low as 3-4%, holding large sums of money in savings accounts for long periods are an opportunity cost that can be easily avoided by using the liquid fund category. The primary need of the investor from this money is safety and easy accessibility.
Liquid funds are suitable for holding money that you don’t need in the next seven days; there is an exit load in that period. For money that is being held for periods of one to two months, liquid funds provide better returns at around 6.5% currently with a strict management of safety and liquidity that the Securities and Exchange Board of India’s guidelines ensure. “Liquid funds suit all categories of investors, even those who are new to mutual funds, since they are unlikely to have a negative experience with it whether it is the return, which is better than that of savings accounts, or the ease with which they are able to manage and access the money," said Gajendra Kothari, managing director, Etica Wealth Management, a wealth advisory firm.
Short-term debt funds
For debt allocations: The State Bank of India (SBI) is currently offering an interest rate of 6%, the lowest in a decade, on FDs for tenors ranging from three to 10 years. For shorter tenors of up to six months, SBI offers just 5%. Bank FDs have been the go-to products for investors for their debt allocations. With inflation, albeit temporarily, at over 7%, there is need for better products to at least protect their savings from inflation.
Well-managed short-duration funds that typically maintain a duration of two to three years can take the place of FDs; they have generated returns of over 9.5%. These funds compensate for the lower interest rate on debt instruments with gains in their value as interest rates come down. This makes debt fund returns volatile but you can offset the volatility by matching the period of investment with the duration of the fund. Other short-term debt funds such as ultra short-duration and low-duration funds too can efficiently stand in for short-term deposits with much better returns. “Short-duration funds, corporate bond funds and banking and PSU funds are good alternatives for an FD investor to consider, as they balance better returns with lower credit and interest rate risks," said Deepali Sen, a certified financial planner and founder partner of Srujan Financial Advisers LLP, a financial planning firm.
Another product that can replace FDs is the Bharat Bond Exchange-traded Fund with yields of 7.3% for the 10-year variant and 6.3% for the three-year one. The ETF yield is tied at the time of investment, if held to maturity, and with a portfolio of government-backed bonds, the credit risk is lower.
For individual bonds: Along with FDs, debentures issued by public and private sector companies are also preferred by retail investors for debt investment. During times of economic weakness, the risk of default is heightened in bonds.
Instead, a bond fund that invests in a variety of bonds will be a safer bet. The fund manager tracks the quality of the bonds and even if there is a default, the impact is smaller since the defaulting instrument forms a small portion of a large portfolio. Investors should ensure that they are comfortable with the credit quality of the bonds held in the fund’s portfolio. “For investors in the higher tax brackets, corporate bond funds and banking and PSU funds for over three-year horizons are good options, given the better post-tax returns that comes from indexation of long-term capital gains tax along with other benefits such as diversification and ease of withdrawal," said Kothari.