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When it comes to investing in Mutual Fund instruments, there are a plethora of choices. A Medium Duration Debt Fund is one of them. As the name suggests, Medium Duration Debt Funds invest in tools for a medium time frame. The Macaulay Duration of these Medium Duration Debt Funds falls between 3-4 years.
The best Medium-term Debt Funds generally deliver an average rate of return between 5 to 7%. These funds are best suited for investors who want to fulfill certain financial goals in a short time frame.
They are also an attractive option for conservative investors as they have a higher maturity than Liquid Funds, Low Duration Funds, Money Market Funds, Short-Duration Funds, and so on. They are also better suited for investors who want to invest in money market instruments other than bank deposits.
While Medium-Duration Debt Funds look attractive on paper, are they worth the risk?
What are the Risks of Investing in Medium-term Debt Funds
All Debt Funds involve risks. Before investing in a Medium-term Debt Fund, it is imperative to understand that it is a Debt Fund. Just like other Debt Funds, they also carry a certain amount of risk.
When it comes to investing in a Medium-term Debt Fund, it is important to know that they also carry three risks:
- Credit risk: Credit risk is the risk of default by the issuer.
- Interest rate risk: Interest rate risk is any effect that the Mutual Fund would have due to either increase or decrease in the interest rate on the value of the funds
- Liquidity risk: It is the difficulty to transfer or encash the Mutual Fund without incurring a loss in the total value of the fund.
Medium-term Debt Funds are considered stable investments with a high potential return and considerably fewer risks as compared to Long Duration Funds. It is important to analyze and research a portfolio before investment. The primary goal should be to earn high returns with reduced credit risks.
As compared to equity-oriented funds, Medium-term Debt Funds are less volatile and considered to be safer. They also have the potential for a superior return compared to other fixed-income products like bank FDs.
Who Should Invest in Medium-term Debt Funds
The purpose of investment is to secure your financial future. Looking at financial goals, you will need to have a strong investment plan so that you meet these goals.
Financial planning gives you an idea about your risk appetite, time period, and the investment option suited to your needs.
Medium-term Debt Funds are best suited for investors
- Who don’t want the risk of investing in equities
- Would prefer better returns than bank deposits
- Have a time period of less than 5 years in mind for their investment.
The best Medium-term Debt Funds have been generally known to provide an average return of 5 to 7% p.a. historically
Where do Medium-term Funds invest
As the name suggests, medium duration funds are invested for a medium time frame of 3-4 years. When it comes to investing, these funds invest in debt securities and money market instruments.
- Debt Securities: Debt securities are financial instruments that hold a promise from the issuer to the holder to pay a specific amount on maturity on a specific date. One of the advantages of investing in debt securities is that they are negotiable instruments.
This means that the holder can transfer the ownership easily. They also have a definite issue date, face value, maturity date, and coupon rate. Debt securities look to ensure repayment of principal along with regular interest payments. Bonds including government, corporate and municipal bonds, are some of the examples. Public-issued non-convertible debentures used by companies are also classified as debt securities.
- Money Market Instruments: By definition as stated by the Reserve Bank of India, money markets are defined as markets where financial assets are lent and borrowed with a maturity period of one year are traded. It enables the trading of instruments for a short-term duration. One of the important features of money markets instruments is giving high liquidity during short maturity. Instruments like Banker’s Acceptance, Treasury Bills, Repurchase Agreements, Certificate of Deposits, Commercial Papers, etc. constitute money market instruments.
The best Medium Duration Funds, invest in the above and are expected to give the investor a healthy return throughout the investment. This makes them a highly sought investment for investors looking for high returns during a relatively short time frame. These instruments of investment are considered to have high liquidity in terms of yield as well as a relatively lower risk factor.
How Long Should I Stay Invested In Medium Duration Fund
The entire premise of investment lies with your financial goals. Investments are planned based on goals. Some of them are short-term, some medium and there are long-term goals. Though there are many investment tools available, conservative investors choose to invest in the best Medium-term Debt Funds to fulfill medium-term goals.
These goals need to be accomplished anywhere between 3-5 years. Investing in a Medium-term Debt Fund will yield the necessary rate of return when invested for the same and specific time duration.
Let’s say you want to buy a new larger vehicle for your growing family in the next 4 years and have some funds in hand. It makes sense then to invest the amount in a Medium Duration Debt Fund and can withdraw what your goal is attained, to finance the car.
The Macaulay Duration of Medium-term Debt Funds ranges from 3 years to 4 years. Based on your financial goal and investment tool of choice, you will need to invest for the same period of time.
What are the Tax Implications of Investing in Medium-term Debt Funds
Medium-term Debt Funds are treated as Debt Mutual Funds for tax purposes.
When invested for less than 3 years, these profits generated from these funds attract short-term capital gain tax which is taxed as per the investor’s income tax slab. However, when they are held for more than 3 years, these funds become more tax efficient.
If invested for more than 36 months, these profits generated from these funds attract a long-term capital gain tax of 20%. With the benefits of indexation, your tax liability would work out to a very low amount.
Frequently Asked Questions (FAQs)
1. Are Medium Duration Fund High Risk?
Medium-term Debt Funds carry credit risk as well as interest rate risk. However, they are considered to be safer than equity-oriented funds.
2. What Kind of Returns can I Earn from Medium Duration Funds?
You can receive an average rate of return between 5 to 7%.
3. Where do Medium Duration Fund Invest?
Medium-term Debt Funds invest in debt securities like government, municipal and corporate bonds. They also invest in money market instruments like Banker’s Acceptance, Treasury Bills, Repurchase Agreements, Certificate of Deposits, Commercial Papers.
4. How Long Should I Stay Invested in the Medium Duration Fund?
Keeping your financial goal in mind, you should stay invested in a Medium-term Debt Fund for 3-5 years.
