Fixed Income Funds

The features of fixed income funds are given below:

1. Consistent Returns: These funds have less risk than equity funds, thereby offering stability, reduces overall risk, and helps in diversifying the portfolio.

1. Systematic Investments: Provides more stability and offers predictable returns than equity funds that helps in fulfilling long-term financial goals.

1. Adaptability: Offers flexibility to switch between funds unlike fixed deposits.

1. Tax Advantage: Tax applied only on redemption as per applicable rates for Short-Term Capital Gains (STCG) tax and Long-Term Capital Gains (LTCG) tax.

1. No Lock-in Period: Does not involve lock-in period, thereby allowing withdrawal of funds anytime, though may have exit loads or other fees depending on the fund type.

Components of Fixed Income Funds

Fixed income funds are not a separate category of mutual funds based on the kind of investment, but rather depend on the style of investment and expected returns. These funds may consist of debt funds, money market funds, exchange-traded funds (ETFs), or Certificates of Deposit (CDs or Fixed Deposit schemes). Let's take a look at each of the above kinds of fixed income-generating instrument:

Debt funds: Debt funds do not invest in the volatile stock market, but prefer safe instruments such as government and corporate bonds and other securities. The profile is low-risk and the returns are stable.

Money Market Funds: Money market funds invest in steady-income tools such as treasury bills, commercial paper issued by corporations, short-term bank certificates of deposit (CDs) and banker's acceptances. These are directly hit by any increase in interest rates and hence are good for short-term investments of up to 90 days.

Exchange-Traded Funds (ETFs): ETFs are index funds that are listed and traded on the exchange like stocks. These indices reflect the changes in the index it associates with, such as Nifty, BSE Sensex or S&P. ETFs can be bought and sold in the cash market from day to day. Gold ETF is one of its most popular forms.

How to Invest in Fixed Income

The ways to invest in fixed income funds are given below:

1. Direct Access to Bond Markets: Investors are offered access to various bond markets, including Treasuries, corporate bonds, and municipal bonds by most of the brokers.

1. Fixed-Income Mutual Funds: Income and professional management are offered to provide exposure to multiple bonds and debt instruments for those preferring not to choose individual bonds.

1. Fixed-Income ETFs: Bonds offered by ETFs are often cost-effective and accessible and focus on specific factors like credit ratings or durations but still involve management fees.

1. Laddering Strategy: Investment made in short-term bonds with staggered maturities that provides steady income, and the principal is reinvested into new short-term bonds after maturity, thereby offering liquidity and protection against a rise in interest rate.

Advantages and Disadvantages of Fixed Income

The following are the advantages of fixed income funds:

1. Predictable Income: Stabilises cash flow by providing regular interest payment.

1. Safety of Principal: Minimises the risk of losing money by investing in funds which are less volatile than stocks.

1. Diversification: Lowers overall portfolio risk by investing in a variety of fixed income securities.

The following are the disadvantages of fixed income funds:

1. Low Potential Return: Hard to grow wealth over time as they offer low returns compared to stocks.

1. Interest Rate Risk: the value of fixed-income investments tends to decrease if the rate of interest increases.

Fixed Income Pros and Cons

The pros and cons of fixed income funds are listed in the table below:

Risks Involved in Fixed Income Funds

The risks involved in fixed income funds are given below:

1. Credit risk: If the instrument’s credit rating is low then the price of fixed income securities will also fall.

1. Interest rate risk: The prices of fixed income securities are inversely related to the rate of interest change. If the interests rate increases the price of fixed income securities fall and vice versa. The sensitivity of fixed income securities to interest rate is known as duration and more the duration more sensitivity to interest rate fluctuations.

What Is the Difference Between Fixed-Income and Equity Securities?

The differences between fixed income funds and equity securities are given below:

How Does Inflation Affect Fixed Income?

Here are the details how inflation impact fixed income funds:

1. The value of fixed-income securities is lowered due to inflation.

1. Bond prices fall when interest rates rise.

1. Bond prices and interest rate are inversely proportional to each other.

Tax Efficiency of Fixed Income Funds

The following are the details about tax efficiency of fixed income funds:

1. Fixed income funds and fixed deposit schemes are taxed differently.

1. Banks deduct 10% TDS (Tax Deducted at Source) from interest earned FD if Form 15G is not submitted.

1. Debt Mutual funds are taxed only when funds are redeemed.

1. If units are sold within 24 months, then Short Term Capital Gains are incurred which are taxed as per applicable rates.
2. Units sold after 24 months will incur Long Term Capital Gain (LTCG) and are exempted up to Rs.125 lakh and amount exceeding this threshold will be taxed at 12.50%. 

Factors to Consider Before Investing in Fixed Income Mutual Funds

The factors to consider before investing on fixed income mutual funds are given below:

1. Financial Goals: Determine your financial goals before choosing a fixed income mutual fund to align with your financial goals in case you have an extra source of income or high return than savings account. 

1. Past Performance: Evaluate the consistency of the fund by comparing the returns and reviewing the track record over the last five to ten years.

1. Investment Duration: align your investment timeline with your return expectations, as fixed income funds have varying maturity periods.

1. Risks: These funds come with various risks, such as credit risk, liquidity risk, interest rate risk, despite providing stable returns.

1. Costs: Considering the expense ratio, low the cost means better will be the return value.

GST rate of 18% applicable for all financial services effective July 1, 2017.