Debt mutual fund and fixed deposit are good investment avenues for those who do not wish to invest in equities. While a large number of investors still prefer fixed deposit as their default investment choice, debt mutual fund offers good alternative.
A fixed deposit is one where you can invest a lump sum amount for a fixed period ranging from 1 to 10 year. A debt mutual fund’s portfolio consists of various fixed income securities such as government bonds, treasury bills, corporate deposits and other debt instruments.
Let’s look in detail the difference between the two to help you decide which is best for you.
Bank FDs offer interest on the amount deposited and is generally in the range of 7%. The interest rate remains the same throughout your term of deposit as it was at the time you booked your FD. Thus the interest rate remains same irrespective of changes in FD rates by the bank.
Debt funds are market-linked. Its returns depend on the interest income of the underlying securities and increase or decrease in value of those securities. If carefully selected and invested for medium to long term, debt funds can provide higher returns than FD.
FDs are considered a very safe investment as Deposit Insurance and Credit Guarantee Corporation (DICGC) insures each bank depositor for up to Rs 1 lakh in the event of bank failure.
Debt funds being market-linked do carry certain amount of risk, though the risk is relatively low compared to equity funds. The funds are closely monitored and regulated by the Securities and Exchange Board of India (SEBI).
FDs can be withdrawn and the amount can be availed within 1-2 days, however, banks levy penalty in case of pre-mature withdrawal. Pre-mature withdrawal is not allowed in tax-saving FDs as they have a lock-in period of 5 years.
Debt funds can also be easily redeemed, though there is an exit load of up to 1% of the redeemed amount, if it is redeemed before a specified period.
The interest income from FD is added to your income for calculation of tax. Thus, the tax on interest income will depend on the tax slab you belong. If your interest income exceeds Rs.10,000 in year, it will also be subject to TDS at 10%. You can however submit form 15G/H so that the bank does not deduct TDS if your income does not fall under the tax slab.
In case of debt funds, if the funds are redeemed before 3 years, profit made on redemption is treated as short-term capital gains and is taxed according to your tax slab. If you redeem it after 3 years, it is treated as long-term capital gain and is taxed at 20% with indexation benefit. This means that your purchase price is adjusted for inflation which helps to bring down the taxable amount. Indexation benefit is a major benefit that debt fund has over FD and thus makes it a preferable choice in long-term.