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Why Debt Mutual Funds are Better than Fixed Deposits

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Fixed deposits have been a part of each and every Indian household. Our grandparents, parents have all ended up in investing in FDs at least once in their lifetime. All bonuses went to FDs. Whenever they had to save money for a goal, they put it in an FD. It was the best option to earn interest while ensuring capital protection.

Over the past few years, mutual funds have come to the core. As a result, FD is no longer considered as the most popular long-term investment goal. In this article, we’ll see how debt funds – a type of mutual funds fare better than the conventional FDs.

  1. A transition from Conventional FDs to Mutual Funds
  2. Why invest in Debt Funds?
  3. Debt Funds vs Fixed Deposits
  4. Taxation on Debt Funds and Fixed Deposits
  5. Comparing the inflation adaptability of Debt Funds and Fixed Deposits

1. A transition from Conventional FDs to Mutual Funds

During the demonetization in 2015, Mutual funds were able to cash in onto the opportunity of the reduced deposit return rates. It was able to perform way better than the FDs, giving returns more than 2x times of the investment. Also, due to the availability of some tax saving mutual funds, mutual funds rose to prominence.

All these factors made no sense for an investor to continue with his conventional FD and so many decided to jump ship.

 

2. Why invest in Debt Funds?

Mutual funds are categorized into three types:  equity funds, hybrid funds and debt funds in descending order of their risks associated respectively. Debt funds are the closest which comes to the conventional FDs in terms of risk.

A debt fund’s main goal is to give investors a steady income after the maturity period, and you must choose a time horizon in line with that of the fund.

You can find out about various debt funds and their duration directly from the fund houses or online or through a third-party. This will help investors understand a fund’s performance with respect to interest and return rates, which makes it easier for you to avoid market volatility by making informed decisions.

 

3. Debt Funds vs Fixed Deposits

Let’s have a detailed look at the differences between fixed deposits and debt funds. The table below helps you decide which investment is suitable for you.

 

ParticularsDebt FundsFixed Deposits
Rate of returns14-18%6-8%
Dividend OptionYesNo
RiskModerateLow
LiquidityHighLow
Investment OptionCan choose either an SIP investment or a lumpsum investmentCan only opt for a lumpsum investment
Early WithdrawalAllowed with or without exit load depending on the mutual fund typeA penalty is levied to withdraw prematurely
Investment ExpenditureAn expense ratio of 2.5% is chargedNo management costs

 

Banks offer a pre-set interest rate for fixed deposits based on the tenure chosen. Debt fund returns are solely dependent on the market movement – they have historically earned higher returns (sometimes even more than double) in the form of capital appreciation on top of interest.

One good thing about fixed deposit is, market highs and lows will not impact the returns you earn. So typically, debt funds outdo fixed deposits by a huge margin during market highs and slightly underscore FDs when the market is down.

 

4. Taxation on Debt Funds and Fixed Deposits

Short-term debt fund( less than 3 years) gains are added to your income and they are taxed at the applicable tax slab. For long-term gains, they are taxed at 20% after the indexation benefits.

Fixed deposit returns are added to your income and they are taxed according to the applicable tax slabs.

 

5. Comparing the inflation adaptability of Debt Funds and Fixed Deposits

Everyone knows that inflation puts a damper on savings as it leads to loss of currency value. Debt mutual funds, albeit the risk, have the potential to pace with inflation. For instance, you have invested in an FD at 7% interest and the inflation rate is 5%, the adjusted return would be a measly 2%. Debt funds deliver better.

Summing up with an illustration

 

ParticularsDebt FundsFixed Deposits
Invested Sum2,00,0002,00,000
Return Rate7%7%
Lock-in period3 years3 years
Fund worth at the end of tenure
2,45,0002,45,000
Inflation6%6%
Indexed Investment Sum2,38,000-
Taxed Amount7,00045,000
Tax to be paid (at 30%)2,333.3315,000
Returns after tax42,666.6730,000

 

Ultimately, you should weigh your decision on your risk appetite, time horizon, and investment goals. All we suggest is that when the market looks positive and you notice several prospects for economic growth, it makes more sense to opt for debt funds than fixed deposits.