Debt Allocation

The author explains that Debt was like the non-striker in a batting partnership, somebody who will hold the other end whilst the big hitting and runs will be scored by the striker, which is equity in this case. It is a no-brainer to invest in mutual funds for one’s debt allocation.

While debt Mutual Funds are subject to long term capital gains taxation of 20% with indexation, returns from fixed deposits and bonds are taxed fully at the income tax rate.

Mutual fund effective tax rate comes to be 5 to 15%. If a bond and a fixed deposit both give 9% pre-tax returns, an investor may get only a 6.3 % post tax return with the fixed deposit. 

The same investor with the same 9 % pre-tax return can get 8.1 % in a mutual fund (because of what amounts to 10% capital gains taxation). In other words, the investor ends up getting approximately 30 % more on a post-tax basis if he takes the debt fund route.

A debt mutual fund’s return is a function of: 

1. Yield to Maturity (YTM) 
2. Mark to Market (MTM)
3. Expense Ratio. 

Debt Mutual Fund’s Return = YTM + MTM – Expense

There is high inverse correlation between credit score and yield to maturity of debt funds. Choose debt  funds on the basis of quality of portfolio rather than the historical returns given by these funds.

High inverse correlation between credit score and yield to maturity of debt funds.

When the required rate of return is higher than Mr. Talwar that is 17.3 percent