India’s stock market has experienced a remarkable ascent, surpassing Hong Kong to secure the fourth position globally with a substantial market capitalisation of $4.33 trillion. The Assets Under Management (AUM) of the Indian mutual funds industry have also crossed the Rs 50 trillion landmark. However, the phenomenal rise in equities and systematic investment plans in mutual funds has led to undue attention to equities. And investors have ignored debt allocation in their portfolios.
While equity-oriented schemes constitute a significant portion of 56.9 percent of the industry’s assets, the proportionate share of debt-oriented schemes accounts for only 17 percent, as per the Association of Mutual Funds of India (AMFI) trends report.
Traditionally, debt funds were the sensible choice for risk-averse investors, a safe harbour offering returns comparable to inflation. But the winds of change blew harshly when the Union Budget 2023-24 altered the game.
Debt funds acquired after April 1, 2023, faced a harsher tax regime.
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Gains from these “specified mutual funds” (those with less than 35 percent equity exposure) are taxed as short-term capital gains (STCG) based on the investor’s income slab rate, potentially reaching a staggering 30 percent. Only after three years does debt limp to a 20 percent long-term rate, devoid of the inflation-adjusting indexation benefit, which was a comfort blanket for long-term investors. This sudden shift has left many debt investors scrambling for tax-efficient alternatives.
These revisions to the tax regime for debt mutual funds, initially intended to create a more equitable landscape with direct investments, have inadvertently tilted the balance towards equity investments.
Now, equity enjoys a clear advantage: short-term capital gains face a manageable 15 percent levy, and long-term gains exceed Rs 1 lakh in a mere 10 percent tax rate (refer to graphic).
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While both equity and debt offer opportunities for wealth creation, the disparity incentivises risk-averse individuals to chase equity returns solely for tax benefits, potentially pulling investors towards equity as an easier available option.
Risks of choosing short-term risks over long-term stability
While equity systematic withdrawal plans (SWPs) offer tempting tax benefits for long-term income, this chase for lower taxes can lead retail investors, especially newcomers, astray. Nearly 30 percent prioritise tax breaks over risk assessment, potentially putting their stability at stake with volatile instruments.
Market volatility
This influx of risk-averse investors into equities solely for tax reasons can inflate unsustainable bubbles and intensify market fluctuations, as seen in the 2015 Chinese market plunge.
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Long-term wealth creation
Chasing short-term equity gains, driven by tax benefits, may ultimately hinder long-term wealth creation. Diversified portfolios with low-risk, tax-efficient instruments like balanced funds or tax-free bonds get ignored, potentially leading to significant losses.
This raises a crucial question: are we jeopardising financial security by making the safer option, debt, less attractive? While equities offer higher returns, their volatility can be unforgiving, especially for beginner investors. Chasing returns with hard-earned savings could easily lead to substantial losses.
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Rebalancing the scales with debt
Recognising the crucial role of debt instruments in creating a balanced and inclusive ecosystem is paramount. A lot has been done to make debt a more alluring proposition for investors:
The Securities and Exchange Board of India (Sebi) has made two key moves to boost retail participation in corporate bonds: slashing the minimum investment size to Rs 1 lakh and regulating online platforms to shield investors from illiquid, unlisted debt. These steps pave the way for wider retail access to attractive bond options with enhanced safety.
Again, the revamped Request for Quote (RFQ) process grants retail investors access to a broader spectrum of debt instruments, including corporate bonds and government securities. This diversification fosters informed decision-making and caters to a wider range of risk appetites.
Digital platforms are democratising debt investments by removing intermediaries and simplifying the process of buying and selling bonds.
Beyond attractive returns, debt offers crucial advantages:
Stability: Debt provides predictable cash flows that anchor your long-term financial plans.
Capital preservation: Your principal investment remains largely safe since the outcome is returned after a certain tenure, protecting you from significant losses.
Diversification: Balancing volatility and mitigating risk, debt bolsters your overall portfolio.
We must recognise that not every investor has the stomach for roller-coaster markets. While debt instruments also carry a certain degree of credit risk and doing due diligence is advised while evaluating any investment opportunity, reported cases of default in the case of such instruments have been few and far between. A healthy financial ecosystem needs instruments for both the thrill-seekers and the risk-averse, and the wise often tend to seek more balance in both their portfolios and their lives.
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Last note
We can ensure that Indian investors have a level playing field where they can choose the instruments that best align with their risk tolerance and financial goals. It’s time to stop framing debt as the “lesser” option and start recognising its crucial role in creating a balanced, inclusive financial ecosystem. Remember, stability breeds confidence, and confidence paves the path to true financial prosperity.
Let’s not turn the harbour of debt into a treacherous shoreline for risk-averse individuals. Let’s make debt attractive again for the sake of financial security and informed investment decisions.
