Why Debt Mutual Funds are Better than Fixed Deposits

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Fixed Deposits (FDs) have been a part of each and every Indian household since decades. The recent years witnessed a slow but 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
  2. Why invest in Debt Mutual Funds?
  3. Debt Mutual Funds vs Fixed Deposits
  4. Taxation on Debt Mutual Funds and Fixed Deposits
  5. Inflation adaptability of Debt Mutual Funds and FDs

1. Shift from Conventional FDs to Mutual Funds

There was a time when every extra cash – bonus, increment – went on to become FDs. Our grandparents, 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, FD is no longer considered as the most popular long-term investment goal.

During the demonetization 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 the conventional FDs in terms of risk. A debt fund’s main 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 taking 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.

 

ParticularsDebt FundsFixed Deposits
Rate of returns7%-9%6%-8%
Dividend OptionYesNo
RiskLow to ModerateLow
LiquidityHighLow
Investment OptionCan choose either an SIP investment or a one-time investmentCan only opt for a lumpsum investment
Early WithdrawalAllowed with or without exit load depending on the mutual fund typeA penalty is levied upon premature withdrawals
Investment ExpenditureA nominal expense ratio is chargedNo 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 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 low interest rates in the economy. 

 

4. Taxation on Debt Mutual Funds and Fixed Deposits

Short-term gains (i.e. less than 3 years) on debt funds are taxable as per your individual tax slab rate. Long-term gains (i.e. up to 3 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 individual 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

 

ParticularsDebt FundsFixed Deposits
Invested Sum (Year of purchase-2015)2,00,0002,00,000
Return Rate7%7%
Holding Period3 years3 years
Fund worth at the end of tenure
2,45,0002,45,000
InflationAdjustment availableAdjustment not available
Indexed Cost of Acquisition (Year of sale-2019)2,20,472-
Taxed Amount24,52845,000
Tax to be paid (assuming highest tax bracket of 30%)4,906 (Tax rate applicable is 20%)13,500
Returns after tax19,62231,500

 

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.