What are the recommended Debt Funds for investment horizon of 3+ years that can provide better than FD returns

There is an RBI monetary policy review meeting on April 5. It is widely anticipated that, RBI will cut repo rate by 25 basis points. With reduction in repo rates, there will be pressure on the banks to reduce fixed deposit rates further. Secondly, the banks were not able to cut fixed deposit rates commensurate with RBI repo rate reductions in the past , because Government small savings schemes were giving high interest rates of 8.5% and more. The Government has now reduced the small savings interest rates starting this financial year (effective from April 1, 2016). This will enable banks to further reduce fixed deposit rates. Also from April 1, the banks are using a new method, prescribed by the RBI to calculate lending rate based on marginal cost of funds. SBI and ICICI Bank have already come up with new base lending rates The new method will not help in transmission of previous rate cuts done by the RBI to the debtors, but also better transmission of future rate cuts. This may put further pressure on fixed deposit rates. The point that we are trying to highlight here is, investors who prefer fixed deposits will have to prepare themselves for lower interest rates in the future.

Historically, we have seen that over a three year tenure income funds have outperformed fixed deposits on a pre-tax basis. On a post tax basis, the gap in returns in far wider. Debt mutual funds, held for over 3 years, are taxed at 20% after allowing for indexation benefits. The indexation benefit reduces the tax considerably. Fixed deposit interest on the other hand, are taxed as per the income tax slab rate of the investor. To understand the benefit of long term capital gains taxation of debt funds over fixed deposits, please see our article, SWP from Debt Mutual Funds give the most tax efficient income over fixed deposits. To see the top performing income funds, please see our article, Top 6 long term income funds in 2015. You can select debt funds mentioned in this article for your investment. However, you should note that, income funds are sensitive to interest rate movements and therefore you will experience some volatility in Net Asset Values when there are bond yield changes. However, with interest rates and bond yields expected to come down over the next few years, based on RBI’s commitment to accommodative monetary policy, one can expect good returns from income funds over the next 3+ years. You should consult with your financial advisor and make the most suitable investment decision.