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Are Debt Funds An Alternative To Fixed Deposits?

Have you ventured into investing in the debt funds? Are you interested in taking the risk of investing in the mutual funds? Are you wondering whether a debt funds are an alternative to Fixed deposits (FDs)? Well an FD is an old and traditional form of investment that is a favourite for every Indian household. Every person with earning would have invested in an FD at least once in their lifetime. This is because fixed deposits are the best means to secure interest along with the capital protection.

With the emergence of mutual funds, fixed deposit is no longer considered as the best investment option. Let us start with the basics and then let us see if the debt funds are really an alternative to the fixed deposits. If so, why have they been considered as an alternative to the fixed deposits?

What is a Debt Fund?

Debt fund is a term that is generally applicable to a broad category of the mutual funds that are aimed at generating income by investing in the securities that can generate good income. These income generating securities can be debentures, treasury bills, corporate bonds, corporate deposits, money market instruments, and debt instruments. Just like mutual funds these can be redeemed or purchased based on their daily NAVs.

What are Fixed Deposits?

Fixed deposits are known as term deposits. They are guaranteed investment tools as they offer capital protection as well as income guarantee till they mature. Banks pay the fixed interest rate throughout the term of fixed deposit. This will not be affected by the variation in the interest rate at any point in time.

Debt funds are considered better than fixed deposits for the following reasons:

  1. Liquidity: Fixed deposit investment is fixed for a particular time period. Before the time period is complete, the money cannot be taken If you wish to break the fixed deposit, then you will have to pay a fine or penalty for a premature withdrawal. Even if you only want withdraw a part of it, you need to pay the penalty on the total amount of mone invested in a fixed deposit.

Debt funds, on the other hand, are liquid. The money invested is available for withdrawal at any point of time, in part or in full amount, and whenever you need it. If you plan to exit before the minimum time duration, then there may be an exit load. This is applicable on the partial amount that you withdraw, and the rest of the money continues to be invested.

  1. Income Tax deduction: With the fixed deposits, the bank charges TDS if the interest obtained in a year is over Rs 10,000. If your PAN card is linked to your bank account the TDS deducted is 10% or else it is 20%. In debt funds, there are no taxes that are paid until the funds are liquified. As long as you retain the debt funds, you need not pay tax.

For those debt funds that have been invested for more than 3 years, the tax rate will be 20%. However, with the advantage of indexation, it turns out to be much lesser.

 

  1. Returns: As of now, the fixed deposit interest is low and around 5% to 7.25%. It was high a few years back but has dropped down significantly in the present. With debt funds, the return expected is very high if the investment period is longer. Hence debt funds are recommended by financial experts because of the stability they offer. So debt funds are a more prudent financial investment regards to the ROI earned.

 

  1. Systematic Investment Plans: Fixed deposits are one time investments. It is a fixed amount that is invested at once, and the benefit is obtained after completion of the term of the fixed deposit. In the case of debt funds, you can invest systematically to meet your requirements. This can be carried over for years by putting in a small amount every month. Debt funds are good options for those who want to increase their assets steadily.

 

  1. Capital protection: Fixed deposits are the safest when compared to the other investment options. Deposit Insurance and Credit Guarantee Corporation (DICGC) and the RBI’s Subsidiary takes up the responsibility and guarantees all the fixed deposits up to Rs 1 Lakh. Debt funds have a risk associated to them because as they offer no capital protection. The debt funds are exposed to the credit and the interest rate risk. However, the risk associated with Debt funds is slow low, and hence you can get comparable to a fixed deposit.

Fixed deposits versus debt funds in a snapshot

Particulars Fixed deposits Debt funds
Returns rate 6% to 8% 14% to 18%
Dividend No Yes
Liquidity Low High
Risk Low Moderate
Early withdrawal The penalty is charged for premature withdrawal Allowed with or without exit load
Investment option No costs 2.5% expense ratio is charged

 

Are debt funds an alternative to fixed deposits?

The answer to this question is a yes and no. It is a yes because Debt funds are more wealth generating in the short term and in the long term and It is a no because they are not as risk-free as a fixed deposit is. However, if debt funds are chosen wisely, this risk can be mitigated. Hence Debt funds definitely have a higher hand in terms of ROI, Liquidity, tax treatment, and investment options. The ultimate decision is always yours and should be based on your risk appetite and investment goals. With a good economic growth expectation making an investment in a debt fund is more pragmatic wealth generating a decision. However, before making an investment in debt funds, you must do adequate research and homework about various aspects such as performance track record, expense ratios, portfolio credit quality, and scheme specific attributes.

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