How Debt Mutual Funds Score Over Fixed Deposits
Of late, several Mutual Fund investors who had migrated from Fixed Deposits in the aftermath of the pandemic induced low interest rate regime are seriously considering reversing their tracks. After all, FD rates are on the rise (in sync with increasing repo rates) and debt funds haven’t exactly delivered stellar returns in recent times. While there’s some merit to the decision of moving 1-year money back to FD’s, there are several reasons why your low risk, 3 year plus corpus should continue to be invested into Debt Funds. Here are three of them for you to consider.
Better Tax Efficiency
While your FD returns are clubbed with your income and taxed as per your marginal tax bracket, Debt Mutual Funds have the benefit of indexation. If you hold on to your debt mutual fund investment for more than 3 years, the purchase price of your units gets indexed basis the change in CII (Cost Inflation Index) between the corresponding Financial Years. For those individuals who fall in the highest marginal tax brackets, this can significantly increase post tax returns. In fact, even in relatively benign-inflation times like these, the effective tax on debt fund profits after 3 years would work out to just 8-10% of the overall profits – a tax efficiency level at par with equities.
Potentially Higher Returns
Fixed Deposits may provide guaranteed returns, but a well-selected portfolio of debt funds can deliver much higher long-term returns than deposits. Although debt fund returns are non linear, there’s a high likelihood that a well managed fund will outperform FD’s over longer holding periods (despite the ups and downs) even on a pre tax basis . Also, as returns from debt mutual funds get compounded whereas FD returns do not, the effective ‘return gap’ as measured in terms of CAGR (Compound Annualised Growth Rate) between the two investment products keeps widening with the length of the holding period.
Better Emergency Access
Fixed Deposits do not allow for partial withdrawals, whereas Debt Mutual Funds do. When you liquidate an FD, you pay a penalty on the entire amount, in terms of reduced interest – whereas, in debt mutual funds, the returns on the remainder of your corpus remains unaffected by your redemption. You can even redeem up to Rs. 50,000 instantly from a liquid fund, which is a category of debt funds. So, for the purpose of planning an emergency fund, debt funds definitely score over their traditional counterpart!
Investing into Debt Mutual Funds can be tricky for novice investors. It is highly advisable to consult a professional Financial Advisor before constructing your portfolio.
