Investing

Fixed Deposit Vs. Debt Funds – Which One Is Better?

Mutual funds that are invested in different types of fixed income instruments are called debt funds. These instruments can be government bonds, corporate bonds, treasury bills, and so on. Since these are not as volatile as equity mutual funds, they are indeed suitable for short term investments. FD has been a preferred choice of debt instrument among Indians. But debt mutual funds give a variety of advantages over them. A few of them are as follows.

LIQUIDITY: The problem with a fixed deposit is that you cannot withdraw the sum before completing the period of your deposit. In case you urgently require to withdraw the amount partially, you need to pay the penalty to do so. But debt mutual funds are comparatively liquid. This makes such withdrawals easy. You can redeem any amount at any time you want it. You might have to suffer some exit load, but that remains applicable to the amount being withdrawn. The rest of the amount remains undisturbed.

TAXATION: 

  1. If the interest is more than Rs.10,000 per year, an additional TDS is chargeable by the bank. If your PAN card is updated with the bank, then the TDS rate is 10%, and if it isn’t, then the figure shoots up to 20%. The situation with debt funds is not the same. You don’t have to pay any tax until your fund is redeemed.
  2. The Fixed Deposit tax rate and that of the debt funds redeemed before 3 years is similar to the tax bracket. But for debt funds held for a duration longer than 3 years, the tax rate is 20% with indexation benefit. This makes the amount comparatively lesser.

RETURNS: FD Returns vary in the range of 5%-7.25%. The exact value might fluctuate, but records say that it comes down to normal after a short period of time. In debt funds, the returns garnered by people have been larger over the past years. They are considered stable and reduce the volatility of every portfolio. The debt portion of the portfolio should be increased with the approach of the investment horizon.

We can also look at a real-time example to validate our points.

CASE1: INVESTMENT FOR 1 YEAR

Amount invested: Rs. 1,00,000

Period: 1 year

Fixed Deposit interest rate: 6.25%

For such a short period, an ultra-short-term debt fund is the best example. Returns might be as high as 8% for a good performer in this case. FD returns are a thing of the future, and debt funds are one of the past, interest rates seem to have gone down generally. So a figure of 7%-7.5% looks like a more realistic figure.

Ultra-short term debt fund returns for a year: 7%

                Fixed Deposits          Ultra Short Term Debt Funds           The gain in Debt Fund
Tax SlabValue at 6.25%TaxFinalValue at 7%TaxFinalAmountPercentage
5%106250312.5105,938107,000350106,6507130.71%
20%1062501250105,000107,0001400105,6006000.60%
30%1062501875104,375107,0002100104,9005250.53%

This chart displays all the tax slabs. This simply proves debt funds have the upper hand on fixed deposits.

INVESTMENT FOR MORE THAN 3 YEARS: Debt Funds on investment for more than 3 years, a long term capital gain or LTCG gets applied. Investors can also take indexation benefits.

Let’s say the amount invested on 18th Sep 2014 is Rs. 1,00,000.

The amount after 3 years is Rs.1,20,000 on the redemption date 19th, Sep 2017, while calculating the capital gains, the cost inflation index needs to be taken care of.

Capital gains can be calculated as

= Purchase value * (Index in 2017-18/Index in 2014-15)

=1,00,000*272/240 = 1,13,333 Rs.

This makes the capital gains to be= 1,20,000 – 1,13,333 = Rs. 6,666.67

LTGC tax rate for debt funds is 20% irrespective of their tax slab, which might even be 30% on the gain after indexation.

Here the tax paid will be=20% of 6,666.67 = Rs. 1,333.33

CASE2: INVESTMENT FOR MORE THAN 3 YEARS

The short term debt funds category will be the most suitable in this case. Past records say that in this case, returns can be as high as 9-10%.

Amount invested: Rs. 1,00,000

Period: more than 3 years; date of investment: 19th Sep 2014; date of redemption: 20th Sep 2017

Fixed Deposit interest rate: 6.25%

Short term debt fund returns: 8%

           Fixed Deposits    Ultra Short Term Debt Funds         The gain in Debt Fund
Tax SlabValue at 6.25%TaxFinalValue at 7%TaxFinalAmountDifference (%)
5%119,946997118,949125,9712,528123,4444,4954.49%
20%119,9463,989,115,957125,9712,528123,4447,4877.49%
30%119,9465,984113,962125,9712,528123,4449,4819.48%

This chart proves that gain in debt funds increases with an increase in tax slabs. The indexation benefit for debt funds is the reason behind this.

After looking at all these cases, debt funds can be considered the better among the two choices quite convincingly.

Source: https://www.myloancare.in/fixed-deposit/fd-interest-rates/sbi

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