Investors today are increasingly weighing their options between traditional fixed deposits (FDs) and systematic investment plans (SIPs) in debt mutual funds. While FDs are known for their fixed returns and safety, debt mutual funds are emerging as an attractive alternative with potentially higher returns over the long term. But which one truly works better for your portfolio? Let’s explore.
Fixed Deposits: The Trusted Savings Option
Fixed deposits are one of the most popular investment options for risk-averse individuals. These are safe and straightforward, offering guaranteed returns at pre-determined interest rates. Currently, most banks in India provide FD rates ranging from 6% to 7.5% for tenures between 1 to 5 years.
Key Features of FDs:
- Guaranteed Returns: Once the FD is locked, the return remains fixed, irrespective of market conditions.
- Tax Benefits: A 5-year FD qualifies for tax exemption under Section 80C of the Income Tax Act.
- Low Risk: The principal and interest are secure, making FDs a low-risk investment option.
- TDS Applicability: Interest above Rs.40,000 in a financial year attracts TDS at 10%.
While FDs are secure, their returns are often lower compared to other options like mutual funds. Moreover, inflation can reduce the real value of your returns over time.
Debt Mutual Funds: A Growing Preference Among Investors
Debt mutual funds invest in fixed-income instruments like government securities, corporate bonds, treasury bills, and commercial papers. Unlike FDs, these funds are subject to market dynamics, meaning their returns may vary. However, over the long term, SIPs in debt funds often outperform FDs.
Why Debt Funds Are Gaining Popularity:
- Higher Returns: Historical data shows that SIPs in certain debt funds have yielded annualized returns between 9% to 24% over five years, significantly higher than FD returns.
- Tax Efficiency: Long-term capital gains (LTCG) tax on debt funds is 20% with indexation benefits, making them more tax-efficient than FDs for higher income brackets.
- Liquidity: Debt funds offer better liquidity compared to FDs, which come with lock-in periods.
- Flexibility: You can choose funds with durations ranging from a few days to over seven years, depending on your investment goals.
Performance of Top Debt Funds
Here’s a look at the performance of some leading debt mutual funds over the past five years:
1. Bank of India Credit Risk Fund
- SIP Returns (5 Years): 24.28% annualized
- Lump Sum Returns: 10.85% annualized
- SIP Value (Rs.10,000/month): Rs.10,94,488
- Total Assets: Rs.114 crore
2. ABSL Medium Term Plan
- SIP Returns (5 Years): 12.69% annualized
- Lump Sum Returns: 12.04% annualized
- SIP Value (Rs.10,000/month): Rs.8,24,998
- Total Assets: Rs.2,004 crore
3. Bank of India Short Term Income Fund
- SIP Returns (5 Years): 10.86% annualized
- Lump Sum Returns: 8.86% annualized
- SIP Value (Rs.10,000/month): Rs.7,88,361
- Total Assets: Rs.85 crore
4. Baroda BNP Paribas Credit Risk Fund
- SIP Returns (5 Years): 9.46% annualized
- Lump Sum Returns: 9.03% annualized
- SIP Value (Rs.10,000/month): Rs.7,61,317
- Total Assets: Rs.169 crore
5. UTI Dynamic Bond Fund
- SIP Returns (5 Years): 9.35% annualized
- Lump Sum Returns: 9.03% annualized
- SIP Value (Rs.10,000/month): Rs.7,59,290
- Total Assets: Rs.507 crore
Comparing Risks
- Fixed Deposits: Virtually risk-free, FDs are ideal for conservative investors. However, their returns may not always beat inflation, impacting the real growth of wealth.
- Debt Funds: While debt funds carry low to moderate risks, they can be influenced by interest rate fluctuations, credit risks, and market conditions. Despite this, they often deliver better returns in the long run.
Taxation: FD vs. Debt Funds
- FDs: The interest earned is fully taxable. Additionally, banks deduct TDS if the total interest exceeds Rs.40,000 annually.
- Debt Funds: Long-term gains (held for over 3 years) are taxed at 20% after indexation, reducing the tax burden significantly compared to FDs.
Liquidity Comparison
- Fixed Deposits: Premature withdrawal from FDs usually incurs penalties, making them less liquid.
- Debt Mutual Funds: Offer better liquidity as you can redeem your investments anytime, though exit loads may apply in some cases.
Missing Aspect: Inflation Impact
One crucial factor often overlooked is inflation. Over time, the fixed returns from FDs may fail to keep up with inflation, eroding your purchasing power. Debt funds, on the other hand, have the potential to outpace inflation, ensuring real growth in wealth.
Who Should Choose What?
- FDs: Best suited for retirees or those looking for guaranteed, stable returns without market risks.
- Debt Funds: Ideal for investors seeking higher returns with moderate risk tolerance and a medium- to long-term investment horizon.
Disclaimer: Past performance of funds does not guarantee future results. Always consult a financial advisor before investing.
