It is quite likely that your grandmother or even your mother would have at some point in time advised you to invest your money in a bank fixed deposit. The reason always being the same, ‘it is safe’. Over the years, the rates offered on bank deposits have varied and ranged between 4% to 12%. When you invest in fixed deposits, you are assured of a certain return and safety of your investment. This is why most people opt to invest in fixed deposits. However, there is another option available for investors looking for relatively low-risk investments. These are debt mutual funds. Before we go on to understand which investment option might be better, let’s understand the key factors of each.
|Fixed Deposit||Debt Mutual Fund|
|Define||When you invest in a FD, you invest a lumpsum amount into a deposit plan at a fixed interest rate and for a fixed period of time||A debt mutual fund invests your money in fixed-income securities like government securities, debentures, corporate bonds and other money-market instruments.|
||Period of investment can be anything from 7 days to 10 years (select institutions offer even 20 years)||Can range from overnight to more than 10 years|
||You get a fixed rate of interest depending on the time period for which you want to invest||The returns you earn will vary depending on the type and duration of scheme selected|
|Risk||Very low risk since the return is known at the beginning of the investment. However, it can be prone to inflation risk||Risk is low to moderate depending on the instruments in which your chosen scheme will invest|
|Liquidity||If you choose to withdraw or close the FD before the end of the investment term then you will have to pay penalty charges||These are highly liquid and you can withdraw your money anytime by redeeming the investment|
||You have a limited choice as interest rates are fixed as per interest rates in the economy||You have the choice to invest across time periods, risk profiles, and potential returns|
|Taxation||You will be taxed as per your income tax slab.||You will be taxed as per your income tax slab if you hold the investment for less than 36 months. For investments held for more than 36 months, taxation is 20% with indexation|
||Lumpsum investment||You can make a lumpsum investment or start a Systematic Investment Plan (SIP). An SIP allows you to invest a fixed amount of money in your preferred scheme at time periods that suit you best. Further, an SIP can be started with as low as Rs. 500|
||It can help you achieve some of your short-term and long-term goals depending on the investment time-period. However, offers limited opportunity for growth||It can help you achieve some of your short-term and long-term goals depending on the investment time-period. Further, you also have the option to grow money and go higher up on the risk curve to generate higher returns|
Why you should consider investing in debt mutual funds over fixed deposits
Debt mutual funds are an ideal option for investors looking for safety and the potential for higher returns.
- Risk: When you invest in fixed deposits, you do so under the assumption that the investment is risk-free. However, this is not the case. There is always the risk of inflation. The interest rates on these instruments are fixed while interest rates, and thus inflation, in the economy, keeps changing. There is always the risk that the rate of inflation will be higher than the fixed deposit rate. Thus, despite earning some returns, the value of the money might not increase at the rate of inflation.
- Taxation: If you are a short-term investor (less than 3 years), then the difference in taxation will have no impact. However, if you are a long-term investor, especially one who falls in the highest tax bracket of 30%, investment in debt mutual funds is far more tax efficient.
- Investment choice: Debt mutual funds will give you an opportunity to invest across time-frames and risk-return profiles. If you are looking to generate potentially higher returns then you can park your money in debt mutual fund schemes that invest in higher-risk companies. On the other hand, if you are looking to invest in low-risk instruments, then you can invest in funds that have exposure to government bonds.
Thus, while fixed deposits have been a preferred investment choice for millions of Indians, it is time that you give debt mutual funds a chance. They offer the benefits of fixed deposits and more.
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