Why Debt funds are good than FD
Investing in Fixed Deposits has been considered the safest bet for normal returns over many decades. But in the present scenario, interest rates on FDs are getting lower and not giving good returns considering the rise in inflation. Naturally, People are forced to think of different alternatives from conventional FDs. As a result, people started to invest in mutual debt funds. Due to this transition, FDs have started slowly losing their sheen. Now, let us know why debt funds are better than FD and many other relevant points to get you a complete picture of this topic.
Let’s start with “What are debt funds?”
Debt funds are a type of mutual fund where the funds are invested on instruments such as (NCD) Non-Convertible Debentures, Treasury bills, Certificate of Deposits (CD), (G-Sec) Government Securities, Corporate bonds,(CP) commercial papers, etc., These debt funds are divided into sixteen categories by SEBI.
Let’s move forward to the next section “Types of Debt funds?”
Liquid Funds are invested in instruments that have a maturity period not exceeding 91 days. Due to this feature, it can be used as a strong alternative to your savings bank account or short-term Fixed Deposits.
Money Market Funds are invested in market instruments with a maturity period not exceeding 1 year. This is suitable for investors with a low-risk appetite.
Dynamic Bond Funds invest in different debt instruments with different interest rates and maturity periods. If you plan to stay invested for a period of 3 to 5 years with a medium risk appetite, then you should go for this fund.
Corporate Bond Funds are invested in highly rated corporate bonds where they deploy almost 80% of their assets. Investment in these bonds carries a low risk.
Banking and Public Sector Undertaking (PSU) Funds invest at least 80% of their assets in total in PSUs and banks.
Gilt Funds put in 80% of the investing limit from their corpus into the G-Sec with different maturity periods. There is no credit risk involved but there is a risk on the rate of interest.
Credit Risk Funds invest at least 65% of their total assets in corporate bonds that come next to high-level ratings. In this fund, you can expect a high rate of return even though there is some credit risk involved.
Floater Fund invests 65% of their corpus that can be used for investment into instruments of floating-rate nature. Interest risk is very low in this fund.
Overnight Fund carries low interest and credit risk as these are invested in funds with a maturity period of one day.
Ultra-Short Duration Fund – The maturity period is between 3 to 6 months.
Low Duration Fund – The maturity period is between 6 to 12 months.
Short Duration Fund – The maturity period is between 1 to 3 years.
Medium Duration Fund – The maturity period is between 3 to 4 years.
Long Duration Fund – The maturity period is more than 7 years.
Now having known what are debt funds and the different types of funds, let’s move on to the crux of this topic which will highlight to you “Why debt funds are better than FDs?”
Comparison of debt funds & FD
For this we look at different factors one-by-one as follows:
Interest Rate: The rate of interest for debt funds usually hovers around 10-12% while for the Fixed Deposits it is around 6%.
Dividend: There is an option to get dividends on debt funds while that is not so the case with fixed deposits.
Risk factor: In the case of Fixed deposits risk is very low and in the case of debt funds, it can be from low to moderate.
Investment Option: In debt funds, you have an option to invest the amount on a SIP (Systematic Investment Plan) basis or also as a lump-sum as you wish. In the case of fixed deposits, only lump-sum investment is available.
Withdrawal: In the case of debt funds, there is a possibility of exit load charges in case of premature closure, but that’s not always so as it depends on the type of debt fund. In case of premature closure of Fixed deposits, there is a penalty that leads to a reduction in the amount of interest you earned.
Expense: For managing your debt funds, you will be required to pay some annual maintenance charges to the debt-fund manager. No such expenses in the case of Fixed Deposits.
Tax-Saving Investments: There is an option to invest in tax-saving Fixed deposits but the interest earned from it is taxable. Debt funds are not an eligible tax-saving instrument, if you want a tax-saving option you should opt for ELSS.
Taxation of Gains or Interest: The interest earned from Fixed Deposits is taxed as per the slab rate of the individual. In the case of debt funds, with a maturity period of fewer than 36 months, the gains are classified as Short Term Capital Gains (STCG) and tax as per the applicable tax bracket. If the holding period of the debt fund is more than 36 months, then you have to pay Long Term Capital Gains (LTCG) tax at the rate of 20% on your net gains after taking into account the benefit of indexation.
After weighing the pros and cons of investing in fixed deposits and debt funds, the ball is in your court now to decide which one to choose. But, I would go with the debt funds as they give over capital growth and wealth creation.
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