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Why Debt Funds are a Better Choice than Fixed Deposits?

Why Debt Funds are a Better Choice than Fixed Deposits?

As fixed deposit interest rates decline to a record low (4%-5%), several investors are thinking about switching to debt mutual funds in India as a viable alternative.

According to a CARE Ratings report of April 2021, inflows into these funds this year were 1.3 times more than that last year. However, FDs made for 88.8% of total deposits this year, a slight fall from its share of 89.5% recorded in May 2020.

Why Should You Invest in Debt Funds?

These funds invest in fixed income tools like corporate and government bonds, certificates of deposit, commercial paper, treasury bills and more. The Securities and Exchange Board of India has classified these mutual funds into 16 types based on where the corpus is invested.

In terms of risks, these funds come closest to conventional fixed deposits. The funds mainly aim to offer investors steady returns throughout the investment period. Based on your financial goal, you can invest in long-term or short-term debt mutual funds.

You can learn about different debt funds and their duration from the asset management companies directly. Then you can understand a fund’s performance in relation to interest rates. Also, you can easily make informed decisions and take advantage of any market volatility.

Difference Between FDs and Debt Funds

Let’s check out how fixed deposits are different from debt mutual funds. Below is a table to help you choose the better investment option.

ParticularsFixed DepositsDebt Funds
Rate of returns6%-8%7%-9%
Early withdrawalA penalty is charged on premature withdrawals.Permitted with or without exit load as per the mutual fund type.
Dividend optionNoYes
Investment optionThe only option is a lump-sum investment.Choose between a one-time investment or an SIP.
Investment expenditureNo management costs.Pay a nominal expense ratio.
RiskLowLow to moderate

As you can see from the table, pros weigh more than cons for investing in fixed income funds.

Banks offer a pre-set interest rate for FDs according to the chosen tenure. Debt fund returns highly rely on the overall interest rate movement. The returns may be moderate (but comparatively more than FD returns) in the form of regular income and capital appreciation. Although market highs and lows don’t affect fixed deposit returns, these mutual funds still outsmart FDs considerably when low interest rates prevail in the economy.

Taxation: On debt mutual funds, short-term gains (for less than 3 years) are taxed based on your tax slab rate. Long-term gains (for up to 3 years or above) are taxed at 20% with the advantage of indexation. When it comes to FD returns, the gains are taxable according to your tax slabs.

Inflation Adaptability: Debt funds have the potential to combat market inflation. If, for example, the inflation rate is 5% when you have invested in a fixed deposit at 6% interest, the estimated returns would be only 1%. However, credit funds may generate comparatively higher returns.

Based on your risk appetite, investment goal, time horizon and income tax slab, you may prefer investing in debt mutual funds over FDs.

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