Debt Funds vs Fixed Deposits – Why Debt Funds are better than Fixed Deposits
Debt funds are the mutual funds which invest in different types of fixed income instruments such as Government Bonds, Corporate Bonds, Money Market instruments, Treasury bills etc. They are suitable for short term investments as they are not as volatile as equity mutual funds.
In India, Fixed deposits have traditionally been the preferred debt instrument. However, Debt mutual funds score over them in multiple ways. In this article we will list the reasons why Debt funds are better than Fixed Deposits.
Once you do a Fixed deposit for a certain period, you cannot redeem from it before the completion of the said period unless you pay a penalty on the whole amount even if you need a part of it. Debt mutual funds on the other hand are liquid and you can redeem whatever amount you want and whenever you want. There may be exit load applicable, however, they will be applied only on the amount you redeem and rest of your amount will remain invested.
a. In Fixed deposits the bank deducts TDS if the interest is more than 10,000 Rs. in a year. The TDS rate is 10% if your PAN is updated with the Bank and 20% if the PAN is not updated. In debt funds no tax has to be paid until you redeem from the fund. Hence you can defer tax payment in debt funds till the period you hold them.
b. The FD tax rate is similar to the tax bracket and it is same for the debt funds redeemed before 3 years. However, for the debt funds held more than 3 years the tax rate is 20% with indexation benefit and hence it comes out to be much lower.
FD Returns are in the range of 5% to 7.25% only. In the past years too FD rates have gone to a maximum of 9.25% only, that too for only a year or so before coming down to today’s level gradually. However, in debt funds the returns have been much better with many funds giving higher returns (example: Intermediate Government Bond Category: 3 Yr Return = 10.08%, as on 30th Aug 2017).
Debt funds provide stability and are recommended to be a part of every portfolio as they reduce the volatility. It is advisable to keep increasing the debt portion of the portfolio as your investment horizon approaches.
For example, for a goal 10 year away you may start with an 80:20 ratio of Equity & Debt, however as the goal completion nears, say now 5 years are remaining, it is prudent to increase the debt allocation to around 50%-60%. Once the goal approaches more close, the debt allocation could be increased to 80%-90% and eventually to 100% when only 1-2 years are remaining.
In our next blog we have used real numbers to demonstrate the same. Read it here
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