Debt Funds Vs Fixed Deposit – Why Choose Debt Funds Over FD?
What does an intelligent investor do when facing the renewal date for their fixed deposit scheme? The investor ought to research and assess the current investment scenario.
This aids in deciding if it is still viable to continue the fixed deposit, or shift to more lucrative investment tools.
A Personal Conundrum
Many investors go through a similar predicament. Being someone who does not completely understand the machinations of the investment world, such investors mostly invest in a low-risk manner.
Fixed Deposits in India are a safe investment instrument as they ensure that you are provided with a fixed return rate.
They have been considered as an ideal choice for investors with a low-risk appetite and limited investment knowledge. I decided to do some research on comparable investment instruments to decide if it is really worth renewing my old fixed deposit.
So, what did I learn?
Debt Fund vs Fixed Deposit – The Current Investment Scenario
Fixed deposits returns were earlier at a high rate of 11–12%. Currently though for one or two year fixed deposits, the interest rate is around 7%.
The recent interest rate cuts indicate that the interest on fixed deposits in Indian banks is diminishing. There seems to be a high chance of the rates declining further.
Another investment option for investors who deal with fixed deposits, is to opt for debt funds instead. Debt funds are an ideal investment instrument for low-risk investors in this changing investment environment.
Debt funds are mutual funds that create investment returns from the deposits made by investors. This is achieved by investing in deposits or bonds of diverse type.
They are different from fixed deposits, as debt funds can invest in tradable bonds. Also, the bonds prices may rise or fall, akin to the stock market.
4 Reasons Why Choose Debt Funds Over Fixed Deposit
1. Tax Benefits
Interest accrues or paid on Fixed Deposits is added to your income in the same year for calculation of Income tax. If you are in the 30% tax bracket, the tax is calculated on your Other Income plus the FD Interest Income together.
No indexation benefit is available here. Further, do note that the tax is deducted at source in case of Fixed Deposits.
In case of Debt Funds, the actual income is accrued on redemption of units only. If the holding period is more than 3 years, indexation benefit is available and the actual gain is reduced in proportion of the inflation before calculation of Income Tax which is at a rate of 20% currently.
This way debt funds are more tax efficient than fixed deposits.
- Also Read – Best Ways to Legally Save Tax in India
2. Improved Liquidity
When deciding to encash your fixed deposit before your maturity date, you should be prepared to receive a little lower interest rate on your deposit. This is like a penalty for prematurely closing the ‘fixed’ deposit.
Debt funds are comparatively easier to en-cash partly or in full, as they allow you the luxury of full liquidity of your investment deposit.
The investor may withdraw any desirable amount of money from the debt fund they are holding. That money will be received in the investor’s bank account in three days.
3. Escape The Paperwork
Fixed deposits require you to pay taxes on the interest that you earn on your investment. You need to collect the Interest Certificate from the Banks and also reconcile the TDS with the Income Tax Form 26AS.
Fortunately, with debt funds it is much easier as you need to pay capital gains tax when you are making withdrawals.
4. Higher Returns
As mentioned earlier in the article, debt funds currently have higher interest rate return when compared to fixed deposits. You can make much more with debt funds than keeping your hard-earned money in the bank.
When you invest in a debt fund, you assume credit risk as well as interest rate risk, this result in better returns.
Please note, returns in debt funds are not guaranteed, and they are subject to some risk. With some homework or help of an advisor, you should be able to select a suitable dept fund easily and can enjoy better returns with debt funds.