Are you trying to decide between target maturity funds vs tax-free bonds for your investment portfolio? In this article, we will pit these two financial instruments against each other in a battle for investment supremacy. On one side, we have the mighty target maturity fund and on the other side, we have the formidable tax-free bond. So which one will come out on top? Read on to find out!
What are target maturity funds?
Target maturity funds are passive debt mutual funds that track an underlying bond index. They can be either Exchange Traded Funds (ETFs) or index funds. Target mutual funds are open-ended funds, but unlike others, these have a defined maturity date. They invest in Public Sector Undertaking (PSU) bonds, Government Securities (G-Secs), and State Development Loans (SDLs).
What are tax-free bonds?
Tax-free bonds allow you to invest a lump sum for a fixed rate of interest and a fixed term. As their name suggests, the interest earned from these bond funds is not added to your taxable income for the year and is hence tax-free. They may sound similar to some traditional term deposits. However, unlike those, tax-free bonds are listed on the stock exchanges.
Now that you know the basic definitions of these two investment options, a side by side comparison can help you get into the finer details.
Target maturity funds vs tax-free bonds comparison
Points of difference | Target maturity funds | Tax-free bonds |
Risk | Target maturity funds are a type of debt mutual fund. Hence, they typically carry low risk.
| Tax-free bonds are low-risk investments that have a fixed interest rate. |
Tenure | The tenure can vary in the case of target maturity funds. | Tax-free bonds generally have long tenures of 10 to 20 years. |
Investing approach | Conservative | Conservative |
Taxation | Target maturity funds are taxed as debt funds. Long-term capital gains earned from investments held for more than three years are taxed at 20% post-indexation. Indexation refers to adjusting the value of your gains based on inflation.
Short-term profits from investments held for less than three years are added to your taxable income and taxed at applicable tax slabs. | Interest earned from tax-free bonds is not taxed. However, gains from bonds held for more than a year are taxed at 10% without any indexation benefit. Further, gains from bonds held for less than a year are added to your taxable income and taxed per the applicable tax rates. |
Target maturity funds vs tax-free bonds: How to choose?
Both these investment options are suited for those with a conservative investment style and looking for long-term gains. Tax-free bonds generally have long tenures and are low on liquidity. And even though target maturity funds are open-ended and relatively more liquid, they may offer higher returns when the target maturity period is increased.
Tax-free bonds evidently offer a tax benefit that may appeal to those who are looking at tax savings. However, target maturity funds offer indexation benefits that can also significantly reduce tax liabilities. It is advised to consider your investment objective and then pick an option.
Conclusion
Target maturity funds and tax-free bonds can be ideal if you have a long-term and low-risk investment approach. The decision to choose between the two must be made after a careful assessment of your long-term goals and tax situation.
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
