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Debt Mutual Funds versus Fixed deposits


Fixed deposits have been a part of each and every Indian’s investment portfolioas it offers an assured interest rate along with safety. However, over the past few years, debt mutual funds are finding a place in the portfolio of those investors who understand debt mutual funds well.

Debt mutual funds are a type of mutual fund that generates returns by investing in bonds or deposits of various kinds, fixed income securities, debentures and Government securities etc. The returns on Fixed Deposits remain fixed whereas returns of debt funds vary because the instruments or bonds in the debt mutual fund portfolio are tradable and the prices are linked to the movement of interest rates as declared by RBI from time to time.

Debt mutual funds provide a wide range of solutions for different investment needs of the investor across risk profiles and investment tenures.

However, there still remain few misconceptions like – 1) Bank fixed deposits always give better returns than debt mutual funds 2) Debt mutual funds are risky 3) Debt mutual funds are for retired people and 4) All debt mutual funds are same.

Therefore, we will now compare debt mutual funds with fixed deposits to clear these myths and also to find out the advantages of debt mutual funds over fixed deposits –

Difference between debt mutual funds and fixed deposits

See the table below which may help you decide which investment is suitable for you.

Particulars Debt Funds Fixed Deposits
Rate of returns 7-12% 6-8%
Dividend Option Yes No dividend but Interest payment option
Risk Moderate to low Low
Liquidity High Low
Investment Option Can invest either through SIP  or lumpsum investment Can only opt for a lumpsum investment
Early liquidity Allowed with or without exit load depending on the debt fund category A charge is levied for premature withdrawal
Expenses An expense ratio of 1.5-2.25% depending upon the AUM and category of the fund No management costs

While fixed deposits offer pre-set interest rates based on the tenure chosen, debt fund returns are solely dependent on the interest rate scenario. Historically, debt funds have given higher returns over fixed deposits. Debt and money market instruments like bonds, CP/CDs etc. can give higher returns than risk free investments. In addition to higher yields, since these papers are traded in the market, their prices appreciate with fall in interest rates or improvement in the credit rating. On the flip side, however, the prices of these papers may fall if the conditions are reversed.

Taxation of debt mutual funds versus fixed deposits

In case of debt mutual funds, short term capital gains (holding period less than 3 years) are added to your income and taxed at the tax slab applicable to you. Long term capital gains are taxed at 20% after allowing the indexation benefits.

On the other hand, the fixed deposit returns are added to your income and they are taxed according to the applicable tax slabs. Moreover, tax is deducted at source (TDS) beyond the threshold limit, on the interest paid by fixed deposits. Whereas, there is no TDS on the gains made by the debt mutual funds (for resident individual investors)

Inflation adjusted returns of debt mutual funds versus fixed deposits

See the table below to understand it better.

Particulars Debt Funds Fixed Deposits
Investment amount 2,00,000 2,00,000
Return rate 7% 7%
Investment period 3 years 3 years
Value at the end of tenure 2,45,000 2,45,000
Inflation 6% 6%
Indexed investment amount 2,38,000
Taxable amount 7,000 45,000
Tax to be paid (at 30%) 2,333.33 15,000
Post tax return amount 42,666.67 30,000

As you may know that inflation puts a damper on your earnings, but debt mutual funds have the potential to keep pace with the inflation. If you see the above example, even if we assume that returns are same for debt mutual funds and fixed deposits, the post-tax returns are higher in case of debt mutual funds as indexation is allowed in case of long term capital gains. For short gains also, the tax on debt mutual funds is only 15% compared to fixed deposits as the earnings are taxed according to the tax slab of the investor.

As we can see there are quite a few advantages of debt mutual funds over fixed deposits. Debt Mutual funds can be good alternative to fixed deposits provided you can select the right debt fund based on the tenure of your investment and your risk profile.

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