The current economic scenario in the country is pretty volatile with the market sending out ‘not-so-bright’ signals to investors. The rollout of GST and demonetization has not been able to showcase its effectiveness, at least, as of now. Even the financial bodies do not have bright predictions for the coming times. Both the Organization for Economic Co-operation and Development (OECD) and International Monetary Fund (IMF) have cut down the growth forecast of the Indian economy to 6.7% from their previous forecasts of 7.3% and 7.4% respectively. Also, the Reserve Bank of India has forecasted a rise in inflation and banks have slashed the interest rates on deposits.
All these figures have raised concerns among investors leading to a debate about the various investment options. The biggest debate is between bank fixed deposits (FDs) and debt mutual funds as both are close rivals and the lowered interest rates on the former have prompted the investors to explore comparatively high-return investment products such as debt funds. So, here is taking a look at the points of differences between the two as well as the advantages and disadvantages offered by them.
- Safety – Bank FDs have been always treasured for their security because they offer credit guarantee and insurance. There is negligible chance of default and the money invested is safe. On the other hand, debt mutual funds are subject to bond market risk and the money invested is exposed to defaults and similar credit related issues. Nevertheless, SEBI and other authorized bodies regulate the latter as well and chances of default are very negligible.
- Tax efficiency – The interest earned from bank FDs as well as debt mutual funds is subject to taxation but the rates differ. In case of FDs, the applicable rate is determined by the tax slab under which the individual falls no matter how long or short the maturity period of the FD. TDS is also deducted on the interest but in case of debt mutual funds, TDS is generally not deducted. The interest earned on these debt funds are classified under long term gains and hence, taxed at 20% after indexation effect, which become very negligible and is very lower than FDs.
- Real rate of return – The rate of return on debt funds is higher and it has been found that they are inflation proof to a large extent. However, FDs do not offer much as they come with a fixed rate of return which does not change during the entire tenure of the fixed deposit.
- Liquidity – Bank FDs are not as liquid as debt funds. They can be redeemed before the maturity period but one has to pay a penalty which is not the case with debt funds. They are highly liquid except fixed maturity plans and interval funds.
- Cost of investment – In case of FDs, the investment cost is zero and the investor gets the entire interest promised under the FD scheme whereas debt funds have an expense ratio. The liquid funds have a ratio of approx. 1% per annum and for other debt funds, it can range between 0.5% to 2.25%. So, debt funds do have some investment cost that impact the return as well.
A quick comparison: Debt Mutual Funds vs Bank FDs
So, one can see that FDs score high on security and cost of investment while debt funds take the cake in terms of real rate of return, tax-efficiency and liquidity. While FDs retain a good deal of their old charm, debt funds come across as a promising and more profitable investment option. So, if an investor is on the lookout for higher returns and willing to take some risk, debt mutual funds are their best bet. The only thing they should keep in mind is that they should assess their risk appetite and future needs properly. Debt mutual funds are really the in thing in the market and it is always wise to invest under different heads as then one can enjoy the security net as well as gains offered by the risk-prone market.
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