Investing their money in a fixed deposit has been the instrument of choice for low-risk investors for generations. But debt funds now present a new challenge and its getting harder and harder to ignore it. In perspective, debt funds and fixed deposits serve similar purposes and are close rivals. The difference between the two is in terms safety, taxation, returns and liquidity. A fixed deposit holds an advantage in safety whereas debt fund holds an advantage in tax-adjusted returns.
A debt fund is a fund that is managed professionally that invests in high rated fixed income earning investments, for example, RBI Bonds, Market Instruments, Government Bonds and Corporate Deposits. The investment pool is collected from the public and the risk factor is quite low. Debt funds are just like mutual funds with the only difference being debt funds are invested in fixed income earning investments whereas mutual funds are invested mainly in stock markets.
A fixed deposit is an instrument provided by banks that provide a higher rate of interest to investors until a given maturity date.
Debt Funds vs. Fixed Deposits:
- As with all mutual fund investment, debt funds also carry a risk and there are no guarantees. The investor gets exposed to any sort of problems like defaulting or credit linked problems faced by the entities in whose bonds they are investing. Banks, on the other hand, have negligible chances of defaulting although cooperative and small banks have defaulted and gone bankrupt in the past. So fixed deposits are the safest investments one can make. But then again, Securities and Exchange Board of India (SEBI) keeps a tight hold on debt fund industry to reduce the risk factor. The measures they have taken are highly effective.
- For debt fund investments longer than 3 years, the returns are categorized as long-term capital gains and they are taxed at 20 percent. However, from fixed deposits, the taxation is more. Fixed deposits are just interesting incomes on top of the average income. Many investors are in top tax bracket which takes a substantial portion of their returns. Banks also deduct TDS on interest income.
- Fixed deposits carry a penalty if they are redeemed before the maturity date. The liquidity of the fixed deposit is available at one or two-day Debt funds are liquidated within two to three days depending on some factors like whether ECS mandate is already registered. Debt funds have exit charges too that are levied for redemptions up to three years, although they are not applied to liquid funds.
You can beat fixed deposits by investing in debt funds, as the returns show. Credit risk and interest rate risk are both assumed by debt fund investors, which mean the investors, are compensated with a higher rate of returns. You can beat the bank by investing in debt funds instead of fixed deposits but you have to choose the right fund to invest in and you should be aware of the risks involved in it.