Selecting a debt investment was easier before April 2023.

Suppose you had extra cash in your bank account. You wanted to park it in a better product. Liquid or overnight funds were an obvious choice.

If you were to buy a house in three-four years, you could invest in one of the three categories – low duration, money market funds, or short duration funds.

But debt funds are not the obvious choice anymore.

Reason: The change in the taxation of debt mutual funds.

So, What Changed?

To know that, let’s first talk about how debt funds were taxed before April 2023. Debt mutual fund taxation was segregated into two buckets depending on how long you invested.

If you sold your investments within three years, you had to pay short-term capital gains tax. Essentially, all the profits you made were added to your income. If you were in the highest tax bracket, you would pay 30% tax on the gains.

But if you sold after three years of investing, you would pay long-term capital gains tax. And this made debt mutual funds a fantastic investment option. Investors had to pay a 20% tax on gains after adjusting them for inflation (called the indexation benefit).

When you adjust profits for inflation, your tax goes down substantially. In most cases, it would be much below 10%.

An example can explain this better. A bank fixed deposit at 8% means a post-tax return of 5.6% for those in the 30% tax bracket. What if your debt mutual offered similar returns after three years? Earlier, there was a good chance that you would make over 7.2% returns after tax.

Where Should You Invest Now?

Earlier, you divided your investment into short-term (less than three years) and long-term (over three years) as debt mutual funds had tax benefits.

Based on the options available now, you will need to be clear if you need money for the short-term (less than two years), medium-term (2-4 years), or long-term (4+ years).