On debt mutual funds, your gains are taxed only on redemption, and tax rate falls the longer you hold the investment. With the new rules coming into force on April 1, this tax arbitrage ends. And thus risk-averse investors—especially the retired—need to reconsider their portfolio construction. Here are some suggestions for individual investors:

Assess short-term impact

Debt funds are good for capital safety and moderate returns. With the tax arbitrage gone, they are at par with fixed deposits (FDs) on tax. The complexity for investors is also how returns are advertised. FDs advertise future returns. Mutual funds can be judged on historical returns. They cannot guarantee future returns. They are a collection of market-linked securities whose values rise and fall every day. Therefore, for short-term needs—under three years—it no longer makes sense to bet on debt funds. Just pick an FD after April 1. If you understand interest rate volatility, refer to the duration strategy.

Also read: Investment blunders I’ve made and what you can learn from them

Reassess long-term plans

Consider who you are, what your financial goals are, and historically what the best instruments have been to achieve those goals. For long-term goals such as retirement, for the young especially, equity investing is necessary to beat inflation. Think equity index funds or ELSS. For the middle-aged, one option is greater exposure to equity to offset the tax hit. Equity-oriented hybrid funds may solve their problem. For the retired, since fixed income is critical, direct investing in the debt markets is an option. But know the pros and cons first.

Make diversification a friend

For all-weather investing, diversify your portfolio across asset classes such as equities, debt, and gold. For instance, investing in gold can provide a hedge against inflation, while equities may offer long-term growth potential. If you are a novice equity investor, start with an index fund. Often, the returns generated by these indices are enough to beat inflation.

Seek higher bank FD returns

For now, the escalating FD rates could give you better returns. You may lock into the longest possible tenors now in the hope that interest rates would soon stabilise.

Look at the retail bond market

Investing directly in listed and unlisted bonds where LTCG is taxed at 10% and 20% without indexation respectively, is now an option. Mutual funds had lowered the buy-in to as little as `500. Now, there are also retail trading platforms that allow you to buy for as little as `10,000. RBI Retail Direct sells government securities while many fintech platforms sell corporate securities. Research before you buy bonds directly.

Go for tax-free bonds

Tax-free bonds are issued by government-owned companies. They can be bought via public issue or on secondary markets. They pay the interest advertised on the bond. This interest is tax-free. The principal is repaid on maturity to the investor.

Also read: Not linking PAN with Aadhaar through e-filing website? Your NPS transactions could be restricted

Check out company FDs, NCDs

One way to assess corporate debt quality is to check the credit ratings assigned to both the debt raise as well as the company itself. An AAA rating reaffirms the highest likelihood of your interest and principal being repaid to you in a timely manner. As always, diversify.

Ways investors can potentially earn higher returns

Investors should remember that earning higher returns from debt mutual funds come with higher risks.

Higher interest rate risks: Proceed with caution. Credit risk funds are debt mutual funds that invest in lower-rated debt instruments. These may earn higher returns than other, safer debt mutual funds.

Consider longer durations: Duration strategy involves taking a view on interest rates and investing in debt instruments of specific maturities accordingly. If an investor believes that interest rates will fall, he may invest in long-term debt instruments, which have higher returns .

Dynamic bond funds: Dynamic bond funds invest in a mix of short-term and long-term debt instruments based on the fund manager’s view on interest rates. However, these carry higher risks compared to other debt mutual funds.

Ride the market volatility: Market volatility can present opportunities for investors to earn higher returns. For instance, when interest rates rise, the value of existing bonds falls, presenting an opportunity for investors to buy bonds at a lower price and potentially earn higher returns when interest rates fall.

Debt funds, bank deposits, and company deposits all have different risk profiles. Investors must carefully evaluate their financial goals, risk appetite, and investment horizon before investing.

NEW SOLUTIONS

* You can invest in government securities via RBI Retail Direct portal

* Tax-free bonds can be bought via public issue or on secondary markets

* Go for equity index funds, ELSS to meet retirement goals

* Evaluate financial goals, risk appetite & investment horizon before making any new investments

The writer is CEO, Bankbazaar.com