When we consider equity funds, the minimum expected holding period does not change with the type of equity fund. In other words, all types of equity funds should be invested in for the long term which can be classified as 5,7,10 years or more.
The same can’t be applied for all types of debt funds as different debt funds serve different needs. The two factors below can help you decide a reasonable holding period for different types of debt funds.
1.The thumb rule to follow
As a thumb rule try to match your investment time horizon with the average maturity of the debt fund. What is average maturity? A debt fund is a portfolio of fixed income securities like debentures and bonds, all maturing (return of principal with all interest pay-outs) at different times. Average maturity indicates the combined maturity profile of the fund portfolio. Let’s say the portfolio comprises of two bonds, A which is 60% of the fund and matures in 4 years and B which is the remaining 40%, maturing in 5 years. The average maturity of the fund is 4.4 years (60%X4+40%X5).
The rule states that if you are looking to invest for say 2 years, find a short-term income fund with an average maturity roughly around 2 years; if your requirement is for 6 months, then look for a liquid or ultra-short-term fund with an average maturity of around 6 months. By doing this you will be able to maximise the return potential of the scheme and at the same time you will not be bothered about the interim changes in the fund’s daily net asset value or NAV.
Debt fund dividends get taxed at the fund level itself, before you receive the pay-out. At the highest level this tax is around 29.12% and at a minimum around 26%. If you opt for the growth option instead, gains will be taxed as capital gains. Short term capital gains in a debt fund are taxed at your marginal rate of income tax.
Alternatively you maybe investing in short term income funds as a part of your overall debt allocation. This can help provide a cushion of steady returns where the portfolio has other growth assets like equity.
Debt fund dividends get taxed at the fund level itself, before you receive the pay-out. At the highest level this tax is around 29.12% and at a minimum around 26%. If you opt for the growth option instead, gains will be taxed as capital gains. Short term capital gains in a debt fund are taxed at your marginal rate of income tax. Selling after 3 years of holding will attract long term capital gains, which is a lot more efficient at 20% after indexation. Indexation refers to the practice of showing gains after adjusting for inflation over the past years. This increases the original cost, thereby reducing the gain.
Thus, for standard debt allocation, its best to opt for growth option and hold your debt fund for at least three years.
These are just guiding factors; in reality you may be compelled to sell your funds before or much after the estimated investment holding period. Hence, don’t base your entire buying decision just on these two factors consider aspects like fund’s credit profile, expense ratio and fund manager pedigree among other things.