Are Target Maturity Funds an Alternative to Fixed Deposits?

Do you want an investment with decent returns? Are you looking for tax efficiency with your investments? You may consider putting money in target maturity funds which is a type of debt fund. It invests in bonds of high credit quality maturing in four to seven years. Are target maturity funds an alternative to bank fixed deposits?

What are target maturity funds?

Target maturity funds are a passive investment in bonds of a similar maturity constituting the fund’s benchmark index, such as the Nifty PSU bond or the Nifty SDL. It is an open-ended debt scheme with a specified maturity date. 

You have target maturity funds investing in India bonds, state government bonds, corporate bonds or a combination of these, matching their benchmark index. You get the amount you have invested and the return on the maturity of the fund. 

You must hold the scheme until maturity if you want to avoid interest rate risk. It is the chance of investment losses due to a change in the interest rates. Moreover, target maturity funds invest in G-Secs (government of India) bonds and state government bonds, which don’t default. Moreover, these funds invest in government-backed AAA-rated bonds of public sector entities, making it a safe investment.

Are target maturity funds an alternative to fixed deposits?

You may invest in target maturity funds if you fall in the higher income tax brackets. It is taxed similarly to debt-oriented funds. You have the long-term capital gains after holding the investment for more than three years taxed at 20% with the indexation benefit. 

It makes your investment in target maturity funds tax-efficient as compared to bank fixed deposits. You have the indexation benefit on target maturity funds cutting the tax burden and pushing up post-tax yields. 

You may invest in target maturity funds instead of fixed deposits only if it matches your investment objectives and risk tolerance. You may avoid these funds if you cannot hold them until maturity or fall in the lower income tax bracket. Moreover, such investors may invest in fixed deposits to attain their financial goals.

What are the advantages of investing in target maturity funds?

• You could consider investing in target maturity funds if you know the time frame of your financial goals. For instance, you plan to go on a foreign tour after three years. It helps if you invest in these funds only if you can hold them until maturity.
• You have target maturity funds as passive investments with a simple portfolio. It avoids fund manager risk, which you face with actively managed mutual funds.
• You may invest in target maturity funds if you seek debt funds with minimal credit risk. It invests in safe government bonds as they don’t default on the principal and interest payments.
• Target maturity funds have an exchange-traded fund (ETF) structure. It translates to a lower expense ratio as compared to other debt funds.
• Target maturity funds show the indicative yields you get on holding them until maturity. It helps you gauge if returns are in sync with your financial goals. However, target maturity funds do not offer guaranteed returns.

What are the cons of investing in target maturity funds?

• Target maturity funds are relatively new in India. You may not have a good track record to judge the performance of these funds.
• Target maturity funds may be vulnerable to tracking error which is the difference between the actual return and those of the corresponding benchmark.

You must invest in target maturity funds only if you can hold them until maturity. It has a portfolio of high-quality bonds and may serve as an alternative to fixed deposits for people in the higher-income tax brackets. In a nutshell, you may allocate a small portion of your portfolio towards target maturity funds and gradually hike the allocation as you understand them. 

For any clarifications/feedback on the topic, don’t hesitate to get in touch with the writer at cleyon.dsouza@cleartax.in