In search of greater tax-adjusted returns, investors have gradually shifted away from traditional savings products like PPFs, fixed deposits, and post office savings plans and towards debt funds. However, while making the switch, they worry about the uncertainty of returns and the possibility of losing their principal. In this regard, Target Maturity Funds (TMFs) are passive debt funds that differ from other debt funds, such as FMPs, in a number of ways.
Let’s look at the characteristics that set this kind of debt fund apart before moving on to the advantages of target maturity funds.
What are Target Maturity Funds?
Target Maturity Funds are funds having a defined maturity date that coincides with the maturity date of the instruments in the fund. They fall under the category of debt mutual funds. These are passive funds that monitor the underlying bond index, making them comparable to index funds or ETFs.
These funds invest primarily in state development loans (SDLs), G-secs, public sector undertakings (PSUs), and other comparable bonds. These mutual funds are open-ended and give investors simple entry and exit options.
Bonds held in the portfolio of Target Maturity Funds regularly pay interest in the form of coupons. These undergo reinvestment in the fund and add to its total performance. Investors get their initial principal investment plus any accrued interest from the reinvestment of coupons at the conclusion of the investment period (the maturity date). This sum represents the entire payoff to investors at maturity.
Benefits of Target Maturity Funds
There are several benefits of investing in these funds, depending on their investment philosophy. Find them below:
These flexible funds have different tenures with the goal of finding yield pockets that seem appealing at a particular time. These funds’ structures are dependent on diminishing residual maturity. It implies that with time, the maturity of the underlying bonds gets shorter and shorter. In this manner, the duration risk continues to decrease. This is even as the fund’s returns become more predictable due to the approach of its stated maturity date.
No Impact of Interest Rate Movements
The returns of these funds remain protected from the effects of scenarios involving rising interest rates. This is because they generally employ an accrual method, keeping debt securities until maturity. Because they retain their bonds until maturity, Target Maturity Funds are less susceptible to interest rate risk than conventional bond funds. This makes them less troublesome in an environment of increasing interest rates. It may otherwise reduce investment value (unless you sell before maturity).
In addition to offering predictability and consistency in returns, these funds are tax-efficient when compared to other investment options. Otherwise, these funds undergo taxation at 20% after indexation. This is when you hold for more than three years.
Short-term capital gains apply when you keep assets for less than three years and have a short-term character. They receive the same treatment as typical investments. These funds gains get added to income and taxed at slab rates. Notably, investment in these funds offers improved liquidity.
Held Until Maturity
TMFs keep the money until it matures. As a result, there are two advantages to holding bonds with different maturity periods until they mature. Since various maturity bonds have varied interest rates, your returns will be a little higher than a single bond fund. Also, because bonds remain until maturity, the danger of an interest rate increase or decline is minimal. As a result, TMFs do not take interest rate fluctuations into account when marking to market.
Who Should Invest in Target Maturity Funds?
Investors looking for a reliable, guaranteed source of monthly income with limited risk tolerance can consider Target Maturity Funds. Investors with medium- to long-term goals that coincide with the fund maturity date might consider these funds. These funds are perfect for investors who wish to eliminate any credit risk, assure liquidity, and gain tax advantages. This is because they invest in registered securities with essentially no risk and also fall under the passive investing category.
Target Maturity Funds Taxation
Target maturity funds is an umbrella term for debt mutual funds. It undergoes taxation in the same way. According to a recent change in the taxation of debt mutual funds, any profits from the sale of units of a debt mutual fund allocating 35% or less of its assets to equity would be short-term capital gains. This is regardless of the holding period. Gains from target maturity funds falling within this category will undergo taxation as per the updated debt mutual fund tax laws.
We are in a stage when the danger of increasing inflation increases by the gradual removal of the liquidity support measures. You can expect no more rate reduction from the RBI. For depositing a portion of your investment, choose a fund whose maturity substantially corresponds to your investment horizon.
Therefore, these funds might work well if you have a medium- to long-term aim. However, the liquidity in them also carries interest rate concerns; if rates increase, bond prices decline, which also affects a scheme’s net asset values. Only if you can retain them to maturity should you think about target maturity funds.