In the world of investments, the journey towards financial freedom is often a long one. It’s a marathon, not a sprint, and it’s essential to have a solid strategy that can withstand the ups and downs of the market over time.
This is where Long Duration Funds come into play. They’re like marathon runners, designed for those in it for the long haul.
For example, think about planning a road trip across the country. You wouldn’t choose a sports car built for speed but with a small gas tank.
Instead, you’d select a reliable vehicle with a bigger fuel capacity to handle the distance. Long Duration Funds are just like that – they offer the potential for consistent growth over a long period.
In this article, we’ll look closer at Long Duration Funds, explaining what they are, how they work, and who they’re best suited for. We’ll also compare them to other long-term investment options so you can figure out where they fit into your financial journey.
What are Long Duration Funds?
Long Duration Funds are debt mutual funds that invest in debt and money market instruments. They have a portfolio with a Macaulay duration greater than 7 years, which measures the weighted average time until a bond’s cash flows are received. In simpler terms, it’s the time until an investor gets back their invested principal amount in a bond through periodic interest payments.
These funds invest mainly in government securities, corporate bonds, and other fixed-income securities with long-term maturities. These funds aim to generate income and capital appreciation over the long term.
These funds primarily invest in government securities, corporate bonds, and other fixed-income securities with long-term maturities. These funds aim to generate income and capital appreciation over the long term.
How do Long Duration Funds work?
Long Duration Funds work by investing in a mix of debt instruments with a long maturity period as a standard feature, usually 7 years or more. The fund manager buys and sells these securities based on interest rate movements and the credit quality of the issuers to generate returns for the investors.
When interest rates fall, bond prices increase, increasing the fund’s Net Asset Value (NAV), resulting in capital appreciation for the investors. Conversely, when interest rates rise, bond prices fall, which can lead to a decrease in the NAV of the fund.
It’s important to note that Long Duration Funds are sensitive to changes in interest rates due to their long maturity period. This sensitivity to interest rate changes is known as interest rate risk.
Who should invest in Long Duration Funds?
Long Duration Funds can be an attractive investment option for various types of investors:
Long-term investors: These funds are ideal for investors with a long-term investment horizon of 7 years or more. The extended maturity period of these funds can align nicely with long-term financial goals.
Risk-tolerant investors: Given their sensitivity to interest rate changes, these funds carry a higher risk level than short-duration funds. Therefore, they are suitable for investors who have a higher risk tolerance.
Investors seeking regular income: Long Duration Funds invest in debt instruments that pay common interest. This can provide a steady income stream for investors, making these funds suitable for those seeking regular income.
Investors looking for diversification: These funds can serve as a good diversification tool within the fixed-income portion of an investor’s portfolio.
Long Duration Funds vs Other Long Duration Investment Options
Long Duration Funds are just one game in town regarding long-term investment options. Other investment options such as Public Provident Funds (PPF), National Savings Certificates (NSC), and Fixed Deposits (FDs) also cater to long-term investors.
| Investment Option | Definition | Suggested Investment Period | Returns | Risks |
| Long Duration Funds | Debt mutual fund that invests in debt and money market instruments with a long duration, usually more than 7 years. | More than 7 years | Varies based on the performance of the underlying securities.
Historically, when viewed over a 5-year investment period, the annual return has been between 8-10%. |
Moderate risk, influenced by interest rate movements and the credit quality of the issuer. |
| Fixed Deposits (FDs) | A financial instrument provided by banks or NBFCs which provides investors a higher rate of interest than a regular savings account. | 1-10 years | Fixed returns, usually higher than savings accounts. (4-7%) | Low risk, as they are not linked to the market. |
| Public Provident Fund (PPF) | A long-term investment option offered by the Government of India, which offers an attractive rate of interest that is fully exempted from Tax. | 15 years | Fixed returns, usually higher than FDs. (7.1%) | Low risk, as it is backed by the Government of India. |
| National Savings Certificates (NSCs) | A fixed income investment scheme that you can open with any post office. It is a savings bond that encourages subscribers – mainly small to mid-income investors – to invest while saving on income tax. | 5 years | Fixed returns, usually higher than FDs. (7.7%) | Low risk, as it is backed by the Government of India. |
Factors to consider before investing in Long Duration Funds in India
Risks
Long Duration Funds are subject to interest rate and credit risks. Interest rate risk refers to the possibility of a change in bond prices due to changes in interest rates. Due to its nature of being a fund with a suggested investment horizon of more than 7 years, it is exposed to interest changes over this time horizon. Credit risk refers to the default risk by the debt instrument issuer.
Returns
Funds with longer investment horizons and exposure to multiple risks, such as those listed above, are considered riskier options than short-term alternatives like liquid funds, overnight funds, and low-duration funds. However, these funds tend to generate higher returns over time, making them an appealing choice for long-term investors. Historically, they have yielded returns of around 8-10% per annum.
Expense Ratio
The expense ratio represents the cost of managing a fund, shown as a percentage of the fund’s average net assets. A lower expense ratio can increase the investor’s net returns and vice versa.
Volatility
Funds with longer maturity periods can be more unstable than short-duration funds. This is because they are susceptible to changes in interest rates and the supply and demand of long-term bonds in the market. These funds do well when interest rates decrease since bond prices (NAVs) and interest rates have an inverse correlation.
Taxation of Long Duration Funds
Like all debt funds, Long Duration Funds are subject to taxation and any returns you make from these funds are added to your total income and taxed according to your income tax slab rate. For instance, if you fall in the 30% tax bracket and make a short-term capital gain of INR 10,000 from your Overnight Fund investment, you must pay INR 3,000 (30% of INR 10,000) as tax.
Conclusion
Including Long Duration Funds in your investment portfolio can be beneficial, particularly if you have a moderate risk tolerance and a long-term investment horizon. These funds present the opportunity for appealing returns while maintaining the stability of debt instruments.
Nonetheless, conducting your research, comprehending the risks, and evaluating the potential returns before committing to any investment is essential.
Long Duration Funds: Frequently Asked Questions (FAQs)
What are Long Duration Funds?
Long Duration Funds are a type of debt mutual fund that invests in debt and money market instruments, such that the Macaulay duration of the portfolio is greater than 7 years.
Who should invest in Long Duration Funds?
These funds are ideal for investors with a long-term investment horizon of 7 years or more, with a higher risk tolerance, and seeking regular income and portfolio diversification.
What are the risks associated with Long Duration Funds?
Long Duration Funds are subject to interest rate risk and credit risk. Interest rate risk refers to the possibility of a change in bond prices due to changes in interest rates. Credit risk refers to the default risk by the debt instrument issuer.
What factors should I consider before investing in Long Duration Funds?
Before investing in Long Duration Funds, assess risks, returns, expense ratio, investment plan, volatility, and bond price.
How are Long Duration Funds taxed?
If you sell your investments in these schemes before three years, the returns (called short-term capital gains) would be added to your income and taxed as per the income tax slab applicable to you. If you sell your investments after three years, returns would be treated as long-term capital gains and taxed at 20% after indexation benefits.
How do Long Duration Funds compare to other long-term investment options?
Long Duration Funds offer the potential for attractive returns while providing the stability of debt instruments. However, they carry a higher level of risk compared to other long-term investment options like Public Provident Funds (PPF), National Savings Certificates (NSC), and Fixed Deposits (FDs).
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