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Where to invest: Debt funds or fixed deposits?

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Traditionally, people with a low risk appetite go for fixed deposits (FDs) as they are a safe source of investment. FDs are very popular, especially with senior citizens who are risk averse. However, with many mutual funds providing an option to invest in debt funds which generate fixed income and assure better returns, investors nowadays have more choices to consider.

We all know that fixed deposits are instruments issued by banks which promise to pay a certain fixed rate of interest on the principal amount for a certain period of time. At the end of this period, the principal along with the accumulated interest (for cumulative schemes) is returned back to the investor. Now, let us briefly understand what a debt fund really is.

What is a debt fund?

A pure debt fund is a mutual fund which would generally invest its corpus in assets generating fixed income. The underlying investments are generally in Central and state government bonds, treasury bills, government securities, high credit rating corporate non-convertible debentures (NCDs) etc. These investments are generally considered very safe as credit rating of the underlying issuing companies/government is very high and a chance of default is negligible.

Like other mutual funds, one can purchase units of these funds based on daily NAVs (for open-ended funds).

Let us now compare fixed deposits and debt funds in detail.

 Fixed depositsDebt fund
How to invest

Most banks offer e-FDs.

However, if you're not sure whether your bank provides this facility, visit  the branch nearest to you.

An existing customer of an MF house can invest online directly. If not, a visit to MF house or CAMS centre is required for investing in a direct plan.
One can also invest online through brokerage houses, like ICICI, Kotak etc., or through agents. However, this will incur a charge of around 0.5 per cent.

Liquidity

Moderate: Generally, pre-mature withdrawal is allowed but it usually attracts a penalty of 1 per cent on the interest rates applicable for the actual term for which the deposit is kept.

High: Redemption can be made any day. Usually, there are no chargest for redemptions after 1 year. However, an exit load of 1 per cent is generally applicable if the fund is redeemed before 1 year.
TaxationAs per the current tax slabs (10, 20 or 30 per cent)Minimum 10 per cent flat or 20 per cent with indexation
Rate of returns6 - 10 per cent7 - 12 per cent
Commission / chargesNILAn MF usually has a fund management charge of around 0.5 per cent, which can be reduced by investing in direct plans. However, the broker may also charge you around 0.5 per cent if you have invested through a broker.
 
Interest ratesFixed for the entire tenureMFs are actively managed and the fund usually seeks to generate returns from various instruments offering different interest rates as per the interest rate cycles
Underlying investmentsNAGovernment bonds, treasury bills, bank bonds, corporate NCDs etc.
Guaranteed positiveYesTheoretically, no, as these funds are market linked and subject to interest rate and credit risks. However, chances of a default are very minimal and hence debts funds are practically safe and give positive returns.
 

Traditionally, FDs have given returns of 6 -10 per cent (depending upon the tenure of investment) over the past 5 years. Let us see what returns some of the best performing debt funds have given over last 5 years. 

Here are five pure debt funds from different fund houses for comparison:

Fund name1 year3 years5 years
Birla Sun Life GSF Long-term 16.09%   10.11%   12.91%
JM G-Sec  13.37%9.16%12.54%
Canara Robeco Income-Reg  12.66%8.91%12.20%
ICICI Pru Gilt Investment-Reg  14.20%9.74%11.60%
Kotak Gilt Investment-Reg14.52%10.46%11.30%
Source - www.valuenotes.com

 

From the above table, we learn that average return from debt based funds has been around 11.75 per cent pre-tax as compared to 9-10 per cent returns given by FDs in the last 5 years.

Even if we assume that both FDs and debt funds will give same returns, say 9 per cent, in the next 15 years, even then post tax returns for debt funds will be much higher for people falling in higher tax brackets (20 and 30 per cent).

Conclusion

Even though debt funds carry negligible risk and have some charges associated with them, they have emerged as a very good investment product for risk-averse investors. They are very tax efficient and hence give much higher post-tax returns. Hence, people, especially in higher tax brackets, should definitely consider debt fund as an alternate source of investment to fixed deposit.

InvestmentYogi.com is a leading personal finance portal.
Disclaimer: All information in this article has been provided by InvestmentYogi.com and NDTV Profit is not responsible for the accuracy and completeness of the same.



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