Fixed deposits (FDs) have been regarded as one of the safest investment avenues for many generations in India. But since the last few years, mutual funds have emerged as a viable alternative to FDs. Both the investment options often get compared as they share similar traits.
The article lists reasons why debt funds are a better investment alternative than bank FDs.
- Inflation-adjusted returns
The Consumer Price Index (CPI) inflation is a crucial factor while deciding the ideal investment option. In India, average inflation rates are between 4% and 5%. With FDs offering an interest of around 6% to 6.5%, it leaves little margin for real returns. In the case of debt funds, investors are generally compensated with higher returns for assuming both the interest rate risk and the credit risk.
- Interest rate benefit
When there is a shift in interest rates, FDs can remain unaffected. However, for debt funds, the price of bonds and interest rate share an inverse relationship. As interest rates go down, the cost of debt instruments can go up. As debt funds invest mostly in corporate debt and government bonds, they enjoy the increased benefit.
- Liquidity
Typically, FDs are not liquid. Plus, you may need to incur extra costs to break an FD before its maturity. On the contrary, debt funds offer higher liquidity. After submitting a redemption request, funds get credited into your account latest by T+1 day. However, some fund houses may charge early exit loads.
- Transparency
When you invest in FDs, there is no way of knowing how the money is ultimately used. With debt funds, you have the benefit of complete transparency on the portfolio disclosure. Additionally, you can calculate the net asset value and know the expense ratio too.
- Flexibility
A fund manager of debt funds has greater flexibility in terms of asset selection and asset allocation. For FDs, there is no such flexibility, and your money is simply lent as commercial and retail loans.
- Tax efficiency
The interest on FD gets added to your total income and is taxed according to the tax bracket you fall in. Thus, the highest rate can be 30%. Plus, banks also deduct TDS on the interest income from FDs. In case of debt funds, if they are held for less than thirty-six months, the tax rates are similar. However, TDS is not deducted on it. In case of debt funds held for more than thirty-six months, a long-term capital gain of 20% is applicable with indexation benefit.
Conclusion
An increasing number of investors are taking notice of the merits of debt mutual funds over fixed deposits, making the shift more pronounced. If you are still new to the mutual fund market, you can start by exploring what is a mutual fund and the different types of mutual funds. Depending on your risk tolerance, you can invest in mutual funds via SIP investment. SIPs in mutual fund allow for a disciplined approach to investing and offers better power of compounding.
