Fixed Deposits v/s Debt Funds: 4 Compelling Reasons to Switch

Fixed Deposits may be your preferred choice, but is it really a wise choice?

This article has been published in “The financial express” on 25th August,2016

As against a case where bank penalizes early exit from FD (generally 1%) if you close it early, the beauty of liquid funds (a category of debt funds) is that there is no exit load on withdrawal.

Fixed deposits (FDs) are a perennial favorite among Indians given the certainty of return and a near zero risk of losing money. However, with time, a new and better product category has emerged which does the same work but in a much more tax efficient and flexible manner. Welcome to debt mutual funds. In this article, let discuss some reasons why debt funds are better than FDs & you should consider them in your investment portfolio.

1: Debt funds are more tax efficient
As per the Income Tax Rules, interest earned from FD is treated as “Income from Other Sources” and it is taxable every year. Hence, in case you are in the 30 per cent tax bracket, your effective return from FD is only 70 per cent of the total interest paid out by the bank.

In case of debt funds, the gain, which is taxed under “Income from Capital Gains”, becomes taxable only at the time of the sale of units, rather than every year. If you hold a debt fund for more than 3 years, the tax rate is 20% with the benefit of indexation. This effectively brings down the tax rate to below 10 per cent.

Another point is that in case of resident Indians, the bank will deduct TDS @10 per cent on FD interest if it is greater than Rs 10,000 in a financial year. In case of debt funds, there is no such hassle.

So, long point short: given the tax angle, a debt fund helps you get a bigger bang on your buck as compared to FD, and is highly recommended option for high earners in the 30 per cent tax bracket.

2: No penalty for early withdrawals
As against a case where bank penalizes early exit from FD (generally 1%) if you close it early, the beauty of liquid funds (a category of debt funds) is that there is no exit load on withdrawal. This means, you have the freedom to redeem your units whenever you need the money, without worrying about penalty costs.

3: Debt funds often provide higher returns
Returns on fixed deposits (except for senior citizens) are often lower than well performing debt funds. This is because the bank retains for itself a fat margin of safety for providing you the ‘assurance’ of a return.

For example, 1-year fixed deposits in most reputed banks today yield 7-8 per cent. Most debt funds (income funds, liquid funds) have yielded over 8 per cent in the past year. While this is of course not a guarantee of future returns, you can often expect debt funds to do better than fixed deposits in most cases.

4: Debt funds are easier to manage
Think about this: every time you save money, you create an FD. At the end of a couple of years, you will be saddled with 10 different FDs with differing maturity dates and interest rates. When you need the money, you may get confused as to which FD you should redeem first. Add to that, there is an ever present hassle of tracking the FD renewal date. Debt funds do not suffer any of these disadvantages. Just open one folio and start investing. When needed, take out the exact amount required and it gets credited to your bank account next day. Simple!

Conclusion
Many of us still carry the legacy of our parents forward and invest in fixed deposits but do not realize that given the dynamic financial landscape, there are better options available now. Debt funds are a perfect mix of flexibility, tax efficiency and convenience and hence a much better alternative than fixed deposits.