Target maturity funds: What are they?
With the popularity of mutual funds on the rise and a fluctuating interest rate landscape impacting guaranteed savings products, many conservative investors are turning towards debt funds. However, these funds also expose investors to default risk, which is the possibility of not receiving principal and interest payments, and interest rate risk, which refers to price fluctuations caused by changes in interest rates. This is where target maturity funds (TMFs) are useful.
Designed to help investors navigate through inherent risks associated with debt funds, TMFs align portfolios with the fund’s maturity date. It offers a dynamic approach, adjusting to interest rate scenarios in real time. Read on to learn more about target maturity funds and how they can be incorporated into your financial plan.
How target maturity funds work?
Target maturity funds are passively managed debt mutual funds that have a predetermined investment objective and maturity date to replicate an underlying index. It holds its securities until the end of the specified term rather than buying and selling them as needed. This means that all interest payments received during the holding period are reinvested in the fund. Upon maturity, investors get their money back plus any accrued interest or returns.
For example, if the fund you choose has a maturity of 2030, it will strategically invest in selected bonds that are set to mature around the same time as the fund itself.
Portfolio composition on target maturity funds
To comply with SEBI regulations, TMFs predominantly invest in high quality government securities (G-Secs), state development loans (SDLs) and public sector undertaking (PSU) bonds, thus mitigating any credit risk.
Some schemes invest in only government securities, while others may include SDLs and PSU bonds. The exact composition of the portfolio will depend on the investment strategy being followed by the fund manager. However, all the holdings are expected to mature within the fund’s stated maturity. This ensures that investors can be reasonably sure when their money will be returned and plan accordingly for their future financial goals.
TMF investments are subject to taxation based on their holding period. Investments held for more than three years are taxed at 20% after indexation benefit. If you hold these mutual fund schemes for less than 3 years, you will incur short-term capital gains tax as per your income tax rate slab. Therefore, investing in TMF can help reduce your overall tax liability if you plan your investments well in advance and stay invested until maturity.
Advantages of investing in target maturity funds
- They provide stability since the funds will hold their bonds until they mature; you can expect predictable returns over time without worrying about market fluctuations or changes in interest rates affecting investments.
- Additionally, these funds tend to have lower fees than most other mutual funds investment schemes due to their passive nature.
- Furthermore, since these funds are backed by government or corporate bonds with high credit ratings, they tend to have very low default risk. Thus, if one of the bonds held by the fund defaults (which is highly unlikely), it won’t affect your overall return significantly due to diversification across multiple securities.
- Being open-ended funds, TMF offers liquidity by allowing investors to enter and exit the scheme any time. However, holding these funds up to the maturity date reflects an investment strategy that wisely considers the predictability of returns.
Should you invest in target maturity funds?
Target maturity funds can be ideal for investors having medium- to long-term financial goals and want indexation and tax benefits after 3 years. These funds also provide liquidity, enabling investors to access their money when needed. However, it’s essential to understand the risks associated with them. When yields rise, bond prices fall, and consequently, the net asset values of the scheme also get impacted. Therefore, it’s wise to invest in these funds only if you can hold onto them until maturity.
Note that even with target maturity funds, investing with caution is always the best approach. So, check all details about the fund, its liquidity risks, fees, and expenses, who manages the scheme, and investment restrictions (if any) before making a decision.