Are Debt Funds Better than Fixed Deposits?

Are Debt Funds Better than Fixed Deposits?

Last Updated: 2021-09-09T16:58:22+05:30 IST

If you are a conservative investor, then bank fixed deposits must have been a preferred option for a long time. In the last few years, yields on bank FDs have been going down consistently. As a result, investors are increasingly looking at other options and debt funds have emerged as a veritable choice for investors. Do debt mutual funds really offer a better choice to investors and how can investors make this choice. Let us look at a comparative analysis before you start your search for best mutual funds in India.

Do debt funds score over FDs on returns?

A G-Sec fund that invests in blue chip government securities is almost as a safe as a bank FD, at least theoretically. We are talking about the default risk. Of course, in terms of market risk, the debt funds run a higher risk and we shall look at that point separately. Let us first check the rates offered by SBI (the largest Indian bank) on its FDs.

Data source: SBI Website

As can be seen from the above table the best yield that investors can get on bank FDs for a holding period of more than 5 years is 7%. Remember these are pre tax returns and not post tax returns. How do these returns compare with the returns on debt funds? For the sake of better comparison, we have considered only G-Sec funds in our list of funds and we have considered five year returns.

Name of Fund

1-Year Returns (%)

3-Year Returns (%)

5-Year Returns (%)

Reliance Gilt Securities Fund (G)




SBI Magnum Gilt Fund (G)




UTI Gilt Fund Plan (G)




Kotak Gilt Investment (G)




Edelweiss G-Sec Fund (G)




Data Source: Morningstar


Clearly, Debt funds give much better returns compared to a bank FD. Short term returns can be misleading hence we have only considered returns of 5 years and above. The average return advantage is nearly 300 bps in favour of debt funds.

Do debt fund score over bank FDs in terms of risk?

This is a trickier question because the bank FDs are almost as safe as a blue chip government paper. If we are purely looking at default risk then there is not much to choose between G-Sec fund and a bank FD and both are very safe in terms of repayment of principal. However, unlike the bank FD, the returns on a debt fund are only indicative and not assured. Hence bank FDs surely score over debt funds in terms of certainty of returns. Also bank FD returns are not volatile but debt fund returns can be extremely volatile when the interest rates start fluctuating. For example, when the interest rates are rising, it can work against the debt funds and in such cases the debt fund could even underperform the bank FDs. Of course, debt funds do give you better returns in a falling interest scenario, which is reflected in higher returns in the table above. However, volatility in returns is an area where bank FDs score over debt funds.

Do debt funds score over bank FDs in terms of tax efficiency?

This is slightly more complicated. Let us first look at the tax treatment of bank FDs. There is no capital appreciation on bank FDs so the entire return is in the form of regular payout of interest only. Now, interest is treated as other income and is taxed at the peak rate of the investor. If the investor is in the 20% bracket, then it gets taxed at 20% and if he is in the 30% bracket then the tax is charged at 30%. In short FDs can be tax inefficient.

What about debt funds. You have two options viz. dividend option and growth option. If you opt for the dividend option, then dividends are tax free in the hands of the investor. However, it attracts dividend distribution tax (DDT) of 29.12% (25% DDT + 12% surcharge + 4% cess). Hence the dividend option can be as tax-inefficient as a bank FD. If you opt for the grown option then 3 years is the cut off for determining LTCG. Any LTCG on debt funds is taxed at 20% with the benefit of indexation. This makes debt funds more tax efficient compared to bank FDs.

Finally, there is the liquidity issue. While debt funds can be bought and sold easily at NAV, the bank FD also offers you loan up to 90% of the FD value. However, if you are looking at a choice between debt funds and bank FDs, then debt funds surely offers you a more productive, more tax efficient and a more flexible option. 

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