Debt mutual funds v/s tax-free bonds: Which is safer?
What's the story
Debt mutual funds and tax-free bonds are two popular investment options for those looking for stable returns. Both have their own perks and downsides, making them suitable for different kinds of investors. In this article, we will look at the safety of these two investment options, comparing their risks, returns, and liquidity. This will help you choose the right option for your portfolio.
#1
Understanding debt mutual funds
Debt mutual funds invest in fixed-income securities such as government bonds, corporate bonds, and money market instruments. They offer better returns than traditional savings accounts but come with some risk as well. The returns depend on the performance of the underlying assets. While they are less risky than equity funds, they are not risk-free. Investors should consider their risk appetite before investing.
#2
Tax-free bonds explained
Tax-free bonds are issued by government-backed entities and offer tax-exempt interest income. They have a fixed maturity period and provide predictable returns over time. Since they are backed by the government, these bonds are considered safer than other fixed-income investments. However, the liquidity of tax-free bonds can be limited due to their long-term nature and market demand.
#3
Risk factors involved
The risk in debt mutual funds comes from credit risk (default by issuers) and interest rate risk (fluctuations in interest rates affecting bond prices). Investors must be mindful of market conditions and fund management strategies. Tax-free bonds have lower credit risk due to government backing but may still be affected by interest rate changes over time.
#4
Comparing returns on investments
Debt mutual funds usually yield higher returns than tax-free bonds due to active management and diversification strategies. However, returns aren't guaranteed as they depend on market performance. Tax-free bonds offer fixed interest rates that remain constant throughout the tenure, ensuring predictable income but potentially lower yields compared to actively managed funds.
Tip 5
Liquidity considerations
Liquidity is an important consideration when choosing between these two options. Debt mutual funds offer better liquidity since they can be redeemed at any time, subject to exit loads if redeemed before a certain period. Tax-free bonds, on the other hand, are less liquid as they have fixed maturity periods but can be traded in secondary markets if needed.