A few years ago, the choice was simple: Retail investors bought Debt Mutual Funds for tax benefits, and institutions bought Direct Bonds.
But today, the lines are blurred. Tax loopholes for debt funds have closed (Section 50AA), and platforms like RBI Retail Direct have democratized bond buying. So, where should you put your money?
💸 The "Cost of Fees" Calculator
See how much a small 1% Expense Ratio costs you over time vs a Zero-Fee Direct Bond.
Assuming 7% annual market return for both.
1. The Basic Difference
When you buy a Direct Bond, you are lending to a specific borrower (e.g., Tata Motors or Govt of India). You know exactly when your money comes back (Maturity) and how much interest you get (Coupon).
In a Debt Mutual Fund, you give money to a manager. They buy 50-100 different bonds. You don't get interest in your bank; instead, the value of your units (NAV) goes up. You never know exactly what your return will be because the manager keeps buying and selling bonds.
2. Comparison Table: Feature by Feature
| Feature | Direct Bonds | Debt Mutual Funds | Target Maturity Funds (TMF) |
|---|---|---|---|
| Control | High. You pick the issuer. | Low. Manager decides. | Moderate. Passive Index. |
| Maturity | Fixed Date (e.g., 2030). | Perpetual / Rolling. | Fixed Date (Target Year). |
| Cost | Zero / Low Brokerage. | Expense Ratio (0.2% - 1.5%). | Low Expense (0.1% - 0.3%). |
| Diversification | Low (Single Issuer Risk). | High (50+ Issuers). | High (G-Sec/PSU Basket). |
3. Target Maturity Funds (TMFs): The Best of Both Worlds?
If you find direct bonds too risky (what if the company defaults?) but hate the uncertainty of normal debt funds (interest rate risk), Target Maturity Funds are the solution.
A TMF acts like a bond. It has a fixed maturity date (say, 2032). It buys bonds that mature in 2032 and holds them. As an investor, you get the diversification of a mutual fund but the predictability of a bond. If you hold till maturity, your return is roughly the "Indicative Yield" at the time of investment.
4. The Tax Angle (Section 50AA)
Previously, debt funds had a massive tax advantage (Indexation). Since April 2023, that is gone for most funds. Now, returns from Debt Funds are taxed at your Income Tax Slab Rate, just like the interest from Direct Bonds.
This levels the playing field. You no longer buy funds just to save tax. You buy them only if you need professional management or diversification.
5. Final Verdict: What should you buy?
- Buy Direct G-Secs/SDLs if: You want 100% safety, zero fees, and regular cash flow in your bank account.
- Buy Target Maturity Funds if: You want to invest for a specific goal (e.g., child's education in 2030) and want safety without the hassle of managing individual bonds.
- Buy Active Debt Funds if: You believe a fund manager can beat the market by trading bonds (Credit Risk Funds or Dynamic Bond Funds), but be ready for higher fees.