Why Debt Mutual Funds are Better than Fixed Deposits

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Fixed Deposits (FDs) have been a part of every Indian household for decades. The recent years, however, is witnessing a slump in FDs with a marked transition to debt funds. In this article, let’s explore why debt mutual funds are better than fixed deposits.

1.Shift from Conventional FDs to Mutual Funds

There was a time when every extra cash – bonus and increment – went on to become FDs. Our grandparents and parents have all ended up in investing in FDs at least once in their lifetime. It was the best option to earn interest while ensuring capital protection. What changed? Over the past few years, mutual funds have come to the core. As a result, FDs have lost its sheen as the most popular long-term investment goal.

During the demonetisation in 2016, mutual funds were able to cash in onto the opportunity of the reduced deposit return rates. Also, due to the availability of tax saving mutual funds, mutual funds rose to prominence. When debt funds started giving more returns with liquidity, many low-risk investors decided to jump ship.

2.Why Invest in Debt Mutual Funds?

Debt funds are the closest which comes to conventional FDs in terms of risk. A debt fund’s primary goal is to give investors steady income throughout the investment horizon. So, 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 rates. It will also make it easier for you to take advantage of the market volatility by making informed decisions.

3.Debt Mutual Funds vs Fixed Deposits

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

 

Particulars

Debt Funds

Fixed Deposits

Rate of returns

7%-9%

6%-8%

Dividend Option

Yes

No

Risk

Low to Moderate

Low

Liquidity

High

Low

Investment Option

Can choose either a SIP investment or a one-time investment

Can only opt for a lump sum investment

Early Withdrawal

Allowed with or without exit load depending on the mutual fund type

A penalty is levied upon premature withdrawals

Investment Expenditure

A nominal expense ratio is charged

No management costs

Banks offer a pre-set interest rate for fixed deposits based on the tenure chosen. Debt fund returns, to a great extent, depends on the overall interest rate movement. They might generate moderate returns (relatively more than fixed deposits) in the form of capital appreciation and regular income.

One good thing about fixed deposits is that market highs and lows will not impact the returns you earn. So typically, debt funds outdo fixed deposits by a considerable margin during times of low interest rates in the economy.

4.Taxation on Debt Mutual Funds and Fixed Deposits

Short-term gains (i.e. less than three years) on debt funds are taxable as per your tax slab rate. Long-term gains (i.e. up to three years or more) on debt funds are taxable at 20% with the benefit of indexation. As for fixed deposit returns, the gains will be taxed as per your tax slabs.

5.Inflation Adaptability of Debt Mutual Funds and FDs

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 6% interest and the inflation rate is 5%, the adjusted return would be a merely 1%. Debt funds may deliver relatively higher returns.

Summing up With an Illustration

 

Particulars

Debt Funds

Fixed Deposits

Invested sum (Year of purchase-2015)

Rs 2,00,000

Rs 2,00,000

Return rate

7%

7%

Holding period

3 years

3 years

Fund worth at the end of tenure

Rs 2,45,000

Rs 2,45,000

Inflation

Adjustment available

Adjustment not available

Indexed Cost of Acquisition (Year of sale-2019)

Rs 2,20,472

Taxed Amount

Rs 24,528

Rs 45,000

Tax to be paid (assuming highest tax bracket of 30%)

Rs 4,906 (Tax rate applicable is 20%)

Rs 13,500

Returns after tax

Rs 19,622

Rs 31,500

Ultimately, you should weigh your decision on your risk appetite, time horizon, and investment goals. Therefore, when the interest rates are at peak, and you notice several prospects for economic growth, it makes sense to opt for debt funds than fixed deposits. You may get good funds at low prices.