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Debt Mutual Funds Vs Fixed Deposits

Mutual funds are becoming the preferred vehicle of investment for many investors due to their ability to offer higher returns when compared to other traditional forms of investments such as fixed deposits, gold, real estate, etc. However, there is also a section of investors who are sceptical of investing in mutual funds due to their high-risk nature. For those investors, debt mutual funds can put their minds at rest.

Also, there is another section of investors who wish to earn interest on their investments but also wish to enjoy capital protection. This section of investors chooses to put their money in banks as fixed deposits (FDs). FDs were considered a safe investment option which is why it was so popular among the masses. Conservative investors found it ideal to invest in fixed deposits due to their low risk, simple nature, and their ability to offer guaranteed returns on completion of the maturity period.

The question that may arise in your mind as an investor is, should you put your money in debt mutual funds or fixed deposits? In the below section, we will provide you with a comparative analysis of both the types of investment which will help you make an informed decision but before that, let us first understand what both these terms mean.

What are debt mutual funds?

Debt mutual funds invest in a blend of fixed income or debt securities such as government securities, treasury bills, corporate bonds, debentures, commercial papers, and money market securities. Returns are generated through the investments which is passed on to the investors as capital appreciation. Units of debt funds, like any other mutual funds, can be redeemed or purchased at the applicable Net Asset Value (NAV) on any given business day.

The Securities and Exchange Board of India (SEBI) has recently re-classified debt mutual funds into 16 categories which have been given below:

Money Market Fund Ultra Short Duration Fund
Banking and PSU Fund Low Duration Fund
Liquid Fund Short Duration Fund
Corporate Bond Fund Medium Duration Fund
Credit Risk Fund Gilt Fund with 10-year constant duration
Floater Fund Long Duration Fund
Dynamic Bond Medium to Long Duration Fund
Gilt Fund Overnight Fund

What are fixed deposits?

Fixed deposits are financial instruments which let investors deposit a lump sum amount of money and let them earn interest on the sum. FDs also ensure protection of the invested money and are offered by banks and Non-Banking Financial Companies (NBFCs). In simple terms, when you put a lump sum amount of money as a fixed deposit for a fixed tenure with an agreed upon interest rate, you will receive the invested amount plus the compound interest on the sum. Fixed deposits are also referred to as term deposits.

The tenure on a fixed deposit can range between 7 days and 10 years. Fixed deposits assure guaranteed returns but will be based on the rate of interest and the type of deposit opted by you. FDs are suitable for investors with low-risk appetite and are one of the safest investment products available.

Comparative Analysis: Debt mutual funds Vs. fixed deposits

Particulars Debt Mutual Funds Fixed Deposits
Return on investment Returns on debt mutual funds can range somewhere between 14% to 18%. Returns on FDs range between 6% and 8%.
Taxation Gains from debt funds that have a maturity of less than 3 years are added to the taxable income and taxed according to the applicable slab. If the debt funds are held for more than 3 years, it will be treated as long-term capital gains and taxed at 20% after indexation. The returns earned on a fixed deposit are added to the income and taxed as per the applicable tax slabs. There is no indexation benefit in FDs.
Liquidity Debt mutual funds are highly liquid which means that units can be redeemed anytime at the prevailing NAVs. However, some mutual funds do charge an exit load if investors exit before a specified period. FDs will attract a penalty if the amount is withdrawn before the maturity period. The penalty will be in the form of payment at reduced interest rates.
Risk Associated Since debt mutual funds deal in the capital markets, some level of risk is associated with it. However, the risk is low when compared with equity mutual funds. Debt funds carry very less risk or no risk at all and hence are known to be the safest investment method.
Investment Options One can invest in debt mutual funds either as a lump sum amount or through SIPs (Systematic Investment Plans). Investments in FDs can only be done as a lump sum amount.

Which one is better? Debt mutual funds or fixed deposits

As mentioned above, debt mutual funds are taxed at 20% and come with indexation benefit. Indexation is the modification in the gains after taking inflation into account. Simply put, the price at which the assets are purchased is calibrated for inflation. Hence, taxes will need to be paid only on the returns that are over and above the initial investment that has been adjusted for inflation. FDs do not have this particular indexation benefit as the debt mutual funds and therefore, when it comes to tax efficiency, debt mutual funds fare better than fixed deposits.

Let us explain this further.

The income you earn as interest from your FDs is fully taxed as per applicable tax slabs and can go up to 30% for those who come under the highest tax bracket. A major portion of your returns can go away in tax if you invest in an FD.

However, do bear in mind that all debt mutual funds are different, serving different purposes. Hence, it is imperative that you take factors such as liquidity requirements, taxation, risk appetite, investment horizon, etc., into consideration before making choosing an investment method.

GST rate of 18% applicable for all financial services effective July 1, 2017.

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