Long-term funds and their benefits and disadvantages

Investing is similar to a marathon. It requires patience, discipline, and endurance to achieve long-term success. Long-term funds like long duration debt funds are like a marathon for your money. As the name suggests, these funds have a long investment term and are suitable for long-term goals. In this article, we will explore the ins and outs of long duration debt funds and how they can potentially benefit your investment portfolio. Keep reading to decode them.

What are long duration funds?

Long duration funds are a type of debt fund. They primarily invest in debt and money market instruments with a Macaulay duration of more than seven years. Long duration funds are open-ended mutual funds. These funds invest in fixed-income securities, like corporate and government bonds, Treasury Bills, etc.

Note: Macaulay duration is a measure of how long you need to hold onto a debt security to get your initial investment back. It was named after its creator, Frederick Macaulay, an economist.

You can check out the advantages and limitations of long-term funds to know more about them.

Advantages of investing in long duration debt funds

• Diversification: Long duration funds can help diversify your portfolio. If you are investing in onlyequity funds and have long-term investment goals, long duration funds can be a suitable addition from the debt category that can seamlessly align with your overall investment objectives.
• Yields: Long duration debt funds generally invest in fixed-income securities with longer maturities, which can offer higher yields than short-term investments. 
• Indexation: Debt mutual funds offer an indexation benefit on investments held for more than three years. The indexation benefit adjusts your investment cost according to inflation and lowers your long-term capital gains tax liabilities.

Limitations of investing in long duration debt funds

• Interest rate risk: Long duration mutual funds are highly sensitive to changes in interest rates, and as interest rates rise, the value of the fund may decline.
• Credit risk:Long duration mutual funds may invest in lower-rated, higher-yielding bonds, which can increase the risk of default.

Apart from the advantages and limitations, there are three more things to keep in mind when investing in these long-term funds.

Things to know before investing in long duration funds

• Risk: Long duration funds may carry a higher risk than other debt funds and thus are suitable for investors with a high risk appetite.
• Investment term:These funds require a long investment term of at least five years to deliver suitable returns.
• Taxation: Long duration funds are taxed as other debt funds. There are two types of taxes imposed on these funds:

• Short-Term Capital Gains (STCG): If you hold debt funds for less than 36 months, any gains you make will be considered short-term gains. STCG is added to your taxable income and taxed at your applicable income tax rate.
• Long-Term Capital Gains (LTCG): If you hold debt funds for more than 36 months, any gains you make will be considered long-term gains. LTCG tax on debt funds is applied at 20% with indexation benefits.

Conclusion

Investing in long duration debt funds can be suitable if you have a long-term investment horizon. This way, you will be able to withstand the potential volatility of interest rates over the years. You can also consider them if you wish to diversify your portfolio. However, make sure to understand their risks and then make a decision.

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