How debt mutual funds outperform fixed deposits?

Fixed deposits (FDs) have historically been the most preferred investment choice for Indian households, providing guaranteed returns and a degree of security, liquidity, and flexibility. However, while they provide a consistent source of returns, some investors may seek to diversify their portfolio and look beyond FDs to unlock potentially higher returns. For these ambitious investors, debt mutual funds may provide an attractive option.

Debt mutual funds invest in fixed-income securities, such as government bonds, corporate bonds, treasury bills, etc., to generate stable returns with reduced risk. But do debt mutual funds outperform fixed deposits, and where should you invest? Here is a detailed comparison of both investments in frequency, liquidity, risk, returns, and tax benefits to help you make an informed decision.

mutual funds

Fixed deposits require a lump sum investment made at the start of the tenure, while debt mutual funds offer versatility in terms of investment opportunities. For example, you can choose from different types of mutual funds per your risk appetite and then decide to make a one-time payment or opt for periodic contributions through a systematic investment plan.

SIPs in debt funds are useful if you prefer to invest small amounts regularly. Besides flexibility, this often allows for better growth opportunities due to rupee cost averaging, a feature that a fixed deposit lacks.

  • Liquidity (premature withdrawal)

With a fixed deposit, you are presented with a specific investment period. Premature withdrawal of fixed deposits often leads to penalty charges imposed by the bank.

On the other hand, debt mutual funds typically do not have any lock-in period, but these investments may be subject to an exit load fee in case of premature redemption. However, this penalty is not imposed on all debt funds, so check the terms and conditions before purchasing.

  • Risk and returns

Fixed deposits are known for their low investment risk, offering returns without volatility. You can expect interest income at a predetermined rate when you make your fixed deposit. Moreover, in case of a bank default, promises up to Rs. 5 lakhs are covered by DICGC insurance. The risk of investing in debt mutual funds is slightly higher because they typically invest in fixed-income securities, which fluctuate depending on the economy’s interest rates. However, this type of risk is still much lower than investing in equity mutual funds.

  • Tax benefits

Regarding tax efficiency, debt funds often fare better than fixed deposits. For debt funds, if the investment has been held for three years or more, you can enjoy an effective tax rate of 20%, along with indexation benefits. Conversely, bank FDs incur tax at the applicable marginal rate, which could be between 30%-40%.

Closing thoughts

Although fixed deposits provide relatively higher safety of principal invested, it usually offers lower returns than debt mutual funds as the latter provides additional flexibility. With a wide range of debt mutual funds to invest in, you can capitalize on market-linked returns and benefit from professionally managed portfolios created with a particular strategy or objective.

While both fixed deposits and debt funds offer certain unique features, it is important to consider your investment goals, investment tenure, and risk appetite to ensure that your chosen instrument is aligned with your financial objectives.

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