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WHY DEBT MUTUAL FUNDS ARE BETTER THAN FIXED DEPOSITS
Fixed Deposits (FDs) are one of the safest options when it comes to saving and investing your hard-earned money, especially for risk-averse investors. However, the popularity of FDs is witnessing a slump in the present times with a marked transition towards debt mutual funds. This results in the debt mutual funds vs fixed deposit query among the people. In this article, we will understand why a debt mutual fund is better than a FD.
Let us start with the basics.
What Is A Debt Mutual Fund?
A debt mutual fund is a mutual fund scheme that allows you to invest in fixed income instruments of investment like Government and Corporate Bonds, debt securities, and other money market instruments that offer capital gains. They are also referred to as Bonds or Fixed income funds.
Major driving factors for debt funds’ popularity include high liquidity, guaranteed return, low-cost structure, and reasonable safety. Debt mutual funds are the best investment option for people with a low risk-bearing capacity as they are less volatile and will help achieve the financial goals in a tax-efficient manner.
What Is A Fixed Deposit?
Fixed Deposit (FD) is a financial instrument provided by the Bank and Non-Banking Financial Company (NBFC). It allows you to invest your funds for a fixed term and earn returns at a fixed interest rate. Plus, fixed deposits offer flexible investment tenures, making them the best and safe investment option.
You put a lump sum amount in a fixed deposit with the said interest rate and for a fixed tenure as preferred. Once the tenure ends, you receive the amount that you had initially invested in addition to the compound interest.
The Shift From FDs to Debt Mutual Funds
While FDs are the most trusted investment instrument, its falling interest rate is the reason why people are taking a shift to the debt mutual funds, which, they believe, can give them better returns. There was a time when all the extra cash, bonus and increments went into FDs for capital protection in the future. But in the present scenario, mutual funds have taken their place as a popular long-term investment.
The debt mutual funds were available at reduced deposit rates during the 2016 Demonetization. These reduced rates attracted people and they started to experiment with the same. This way, debt mutual funds cashed their opportunity and with increasing returns, high liquidity, many low-risk bearing investors decided to jump ship. This is how the big shift happened and people started to consider debt mutual funds as a better option than fixed deposits.
Debt Mutual Funds vs Fixed Deposits
Here is a quick comparison between debt mutual funds and fixed deposits to make you understand why the latter is more preferred.
Rate of return: 7% to 9% in debt funds and 6% to 8% in FD.
Dividend option: Available in debt funds but not in FD.
Risk: Low to moderate in debt funds but low in FDs.
Liquidity: Debt funds have higher liquidity than FDs.
Interest rate: The interest rate in debt funds depends on the overall market movement, whereas, the interest rate on fixed deposits is pre-set based on the chosen tenure.
Investment option: mutual funds offer investment options like SIP, while FD has one type of lump-sum investment.
Early withdrawal: Is allowed in debt funds with or without exit load based on its type, however, a penalty is levied upon premature withdrawal from FD.
This quick comparison gives you a clear picture of which one is the best, debt mutual fund or fixed deposit.
Additional Comparison Parameters
If you are still stuck on debt mutual funds vs fixed deposits, here are some additional parameters to compare and understand why debt mutual funds are considered the best, today, when compared to an FD, based on interest rates, tenure, withdrawal, etc.
Interest rates on fixed deposits are table based on the current tax slab of the individual, whereas, the taxation on debt mutual funds depends on its holding period.
This means that the interest you earn against your FD is added to your net income and taxed accordingly. The same is levied if the earning exceeds Rs. 40,000 for regular residents and Rs. 50,000 for senior citizens in a financial year.
Debt mutual funds, on the other hand, are treated as capital assets. This means that a capital gain tax is applicable on them. But, there are certain complexities as debt funds are either short term with a 3 years tenure or long term with over 3 years tenure. Now, if you redeem the fund before 3 years, it will be counted as a fixed deposit, meaning that you will be subject to income tax just like your FD. It may be further noted that debt funds are taxed at 20% indexation and 10% without indexation if held for over 3 years.
- Inflation Adaptability
We all are aware of the intensity of damper inflation can bring on our savings as it leads to the loss of currency value. To control the same, policymakers use the key policy rates on deposits and lendings.
Given the information, the interest rate offered on FD and the annual return on debt funds are closed at the rate of inflation. While the FD remains unaffected as the interest rate is pre-decided, they may lose the value in case the inflation exceeds the decided rate. This makes FD an inflation inefficient instrument.
Debt funds, on the other hand, have the potential to beat inflation and generate better returns, however, subject to risk. They absorb the effect of inflation, as it is a fixed return instrument and can be traded in the secondary market.
The returns on fixed deposit and debt funds are different and based on the term of deposit, type of investor you are and the market rates at present. On the upside, the repo rate is the major driving factor for market rates.
In the case of FD, the interest rate remains fixed for the entire investment period, which, in turn, gives it a higher maturity value. However, when the market rate falls, the FD interest rates also fall and vice versa. While there is a little risk involved, your FD will continue to earn interest at a fixed rate.
Debt funds, unlike FDs, have a varying rate of return. Though they are market-linked but have proven to outperform FDs in the past, especially during low interest rates in the economy. This makes debt funds one of the best options vis-a-vis FDs.
To sum up,
Debt funds are considered a better investment option, today. This is because of their flexible returns and tenure, early withdrawal feature, inflation adaptation and a variety of options. Further, you should always consult a required financial service provider like Muthoot Finance to ensure correct and adequate guidance for your trading.
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