Why Are Debt Mutual Funds A Better Alternative To FDs?
17 Apr 2017
Nutan Gupta
New Page 1
A Debt Fund is a mutual fund which invests in fixed income securities.
Fixed income securities include government bonds, certificate of deposit, commercial
papers, treasury bills and corporate bonds. Investors with a low-risk appetite consider
investing in debt mutual funds and fixed deposits (FDs). In one of our articles earlier,
we had discussed the different types of debt mutual funds. This article will tell you why
investing in debt mutual funds should be considered over FD.
Safety of capital is same
The safety of any instrument depends on the credit rating of the
instrument. Fixed deposits with a AAA rating implies that it carries the highest level of
safety. Debt mutual funds are not rated by themselves but their safety can be identified
from the portfolio they invest in. While sovereign rating indicates the highest level of
safety as it is issued by the Government of India, AAA and AA rating also indicate a high
level of safety as the funds are issued by banks, public sector companies and private
companies. Moreover, Securities Exchange Board of India (SEBI) being the regulator, keeps
a close watch on the fund industry.
Debt funds provide higher returns
Fixed deposits provide fixed returns. At present, the interest rate
provided by FDs is 6.5%. If one looks at the historical performance of debt mutual funds,
it has given returns of 8-9%. Interest rate fluctuations can cause volatility in debt
fund, otherwise they are very safe investments.
Taxation
The returns from fixed deposits are considered as interest income and
hence are added to an individual’s normal income. An individual whose income comes in
the tax bracket of 30%, tax takes away a large chunk of his returns. The tax rate is same
for debt funds held for less than 36 months. However, if debt funds are held for more than
36 months, long term capital gain is applied and the returns are taxed at 20% with
indexation.
Debt funds provide better liquidity
The proceeds of open-ended debt funds are credited to an
individual’s bank account in 2-3 days. Although fixed deposits can also be liquidated
in 2-3 days, there is a penalty for withdrawing FDs before the maturity date. Some debt
funds may charge you exit load which is usually 0.25% if you withdraw within a certain
period of time.
For example:
Mr. Shah has invested Rs. 1 lakh each in a Bank FD and Debt Fund for a
period of 3 years and 1 day. The expected return for both these investments is 7.5%. Which
investment will give him a better post-tax return?
|
Investment
in FD
|
Investment
in Debt Fund
|
Amount with
interest/return
|
Rs. 1,24,230
|
Rs. 1,24,230
|
Index Cost
|
NA
|
Rs. 1,15,763
|
Tax Applicable Rate
|
30% (Higher Tax Slab)
|
20%
|
Taxable Gain
|
Rs. 24,230
|
Rs. 8,467
|
Tax Payable
|
Rs. 7,269
|
Rs. 1,693
|
Net Return (p.a.)
|
5.40%
|
7.00%
|