Making the right investment choice between Debt Mutual Funds and Bank Fixed Deposits
Looking to park funds for 3 to five years or even for a few months? The two investment options that immediately come to mind are – bank fixed deposit (FD) and debt mutual funds. But, how to decide between the two? Which is a better option between bank FD and debt fund will depend on one’s own specific needs, tax slab, and risk profile.
Therefore, before deciding to invest in either of them, here are some important pointers that you may not want to ignore. After all, it’s your hard earned money and you will want to earn the maximum out of every rupee that you wish to invest. Let’s explore them.
Bank fixed deposits are plain vanilla investments and carry a fixed return for the tenure you want to park the funds. Safety of money is high in them as deposits ( including interest) are insured by the government up to Rs 5 lakh per bank per person. Although, there has not been a default among leading banks any amount above that limit is exposed to the risk.
Further, there could be a penalty imposed by the bank if you wish to surrender the deposit before its original maturity date. And, most importantly, the interest earned in FD is fully taxable as per one’s income slab. From a taxation angle, this makes FD unsuitable to those who are in the highest tax slab.
Now, let us see what debt funds are, and what they have to offer to investors.
A debt fund is a type of mutual fund that invests in fixed-income securities and not a single rupee of your investment goes into the share market. Here is where a debt fund holds your money – corporate and government bonds, and money market instruments. They are also referred to as ‘Income Funds’ in the mutual fund industry.
Before you invest in a debt fund, here’s an important take. There are 16 different categories of debt funds, choose carefully or ask your financial planner to zero in on the right one.
Since debt funds can be either long-term or short-term, choosing the appropriate one might be crucial based on your financial goals. In contrast to short-term debt funds, long-term funds have a longer time horizon and often invest in assets with maturities longer than one year. They also offer a constant income with less volatility.
Five of the 16 different debt fund categories are appropriate for parking short-term funds since they contain securities with a shorter maturity profile. Choose from overnight funds, liquid funds, ultra-short duration funds, low duration funds, and money market funds if you want to choose a length between a few days and up to a year. Each of these groups will have underlying securities with a specified maturity profile, which could be three months, six months, nine months, or twelve months.
Talking about returns, unlike FD, there is no fixed interest rate or return in them. However, debt funds have the potential to generate higher returns than FDs as they are market linked in nature. Based on the movement of the interest rate in the economy, the debt funds, especially the Dynamic Funds, have the potential to benefit from changing interest rate environment.
Here’s another clincher in favour of debt funds. The effective returns in debt funds are also higher because of the tax advantage they have over bank FD. Gains on debt funds that have been held for less than three years are taxable at your individual tax rate. Gains on debt funds that are long-term (i.e., up to three years or longer) are taxed at 20% with the benefit of indexation. The gains on fixed deposit returns are taxed according to your tax brackets.
So, if you are in the higher tax slab and looking to park funds for a short-to-medium duration, you now know which investment option is right for you.
Still, as every individual’s needs are different, we are here to help you out carve out a specific investment plan based on your goals, needs, and aspirations. To know where to park your surplus funds and get the most out of it, do get in touch with us by clicking here.