Are debt funds still relevant in a post-COVID investment landscape?

The COVID-19 pandemic reshaped global investment behaviour, introducing great uncertainty and encouraging a “flight to safety.” As economies recovered and retail investor confidence strengthened, strategies continued to evolve.

Amid this shift, debt mutual funds remained a reliable option. But how relevant are they today—particularly with new taxation rules in place?

What are debt mutual funds?

Debt funds pool investors' investible money into fixed-income instruments—government bonds, corporate debt, treasury bills and money market instruments. These funds target at offering steady returns with minimal risk than equity market investments. This makes them a good option for risk-averse retail investors seeking capital preservation along with regular income.

The role of debt funds in a post-COVID market

Post-COVID, debt mutual funds faced liquidity stress and a demand for greater transparency. This period acted as a stress test, prompting regulatory tightening and major improvements in risk management. As an outcome, today’s debt mutual funds are better governed, more quality-driven and safer for long-term investors.

With interest rates stabilising and inflation tapering, demand for short- and medium-term debt funds has picked up. These funds are now preferred for their potential to offer predictable returns, lower volatility and high liquidity, making them a strong addition to a balanced investment portfolio—particularly for those aiming to maintain stability without entirely exiting market-linked products.

Debt mutual fund taxation rules

A major post-COVID change in the debt mutual fund vertical has been in taxation, impacted by the Finance Act 2023 and the Budget. Knowing these changes is imperative for optimising post-tax returns, particularly for retail investors involved in the planning for long-term wealth generation.

• Post-April 1, 2023 investments

For debt mutual fund units that are bought on or post 1st April 2023:

• All capital gains, irrespective of holding period, are viewed as short-term capital gains (STCG)
• Taxed at the investor’s applicable income tax slab rate
• No indexation benefit and no separate long-term capital gains (LTCG) treatment

This move has reduced the tax efficiency of debt mutual funds, especially for those using them as long-term alternatives to fixed deposits. It also blurs the distinction between fixed-income funds and traditional instruments from a tax perspective.

• Pre-April 1, 2023 investments

Investments made before 1st April 2023 are grandfathered under the older and more favourable rules:

• STCG
  • Applies to holdings ≤ 36 months
  • Taxed as per slab rate
• LTCG
  • Applies to holdings > 36 months
  • Taxed at 20% with indexation, allowing adjustment of purchase price for inflation

This older structure remains attractive for legacy investors and should be considered when planning redemptions.

• Budget 2025 highlights: Tax relief impact

The Union Budget 2025 introduced expanded relief under Section 87A for those opting for the new tax regime:

• Individuals with income up to ₹12 lakh are now eligible for full tax exemption
• This benefits those holding post-2023 debt mutual fund units, as STCG taxed at slab rates can be offset within the increased rebate limit

Important: This rebate does not apply to LTCG taxed at flat 20% with indexation, which is still relevant only for pre-April 2023 investments.

Key benefits of debt mutual funds

Despite taxation changes, debt funds offer strong benefits:

1. Portfolio diversification

They reduce volatility by balancing equity-heavy portfolios.

2. Stable returns

Debt mutual funds provide predictable income, which is valuable during economic uncertainty.

3. Flexibility

Investors can choose lump-sum or systematic investment plan (SIP) investment methods, making them accessible to all types of investors.

4. Relative tax efficiency (pre-2023 units)

Legacy investments still enjoy LTCG benefits with indexation, lowering effective tax outgo.

Risks and considerations

Despite their benefits, debt funds come with certain risks:

• Credit risk: The risk of default by issuers of the underlying securities.

• Liquidity risk: The possibility of not being able to sell securities quickly or at favourable prices.

• Interest rate risk: Bond prices tend to fall when interest rates rise, impacting fund returns.

Using a mutual fund returns calculator

A mutual fund returns calculator is a helpful tool to estimate potential returns from debt fund investments. By inputting the investment amount, expected rate of return, and time horizon, investors can gauge how their money might grow. This is particularly helpful when comparing debt mutual funds against traditional fixed-income options.

Do debt funds still make sense after COVID?

Debt mutual funds have evolved significantly post-COVID—both in structure and taxation. While they continue to offer stability, diversification, and consistent returns, new tax rules have reshaped their long-term attractiveness, especially for fresh investments made after April 1, 2023.

However, with improved regulatory oversight, better risk management, and flexible planning tools like returns calculators, debt mutual funds still hold value in a modern investment portfolio. For those with legacy investments or utilising the new tax regime rebates, they remain a smart choice for wealth preservation and moderate growth.

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