Know the differences between Debt Mutual Fund and Bank Fixed Deposit

The investment experts all over the world advise investors to prefer debt mutual funds over bank FDs. This is especially relevant during the falling interest rate regimee. In the present article, the author compares various factors in respect of debt mutual fund and bank FD. The article would help the investors to take informed investment decision.

There are various types of investors. Some like to take risk and some don't like to take risk. The risk-averse investors generally don't invest in direct equity or equity mutual funds. To them, protection of their capital is the first priority. After that they seek return from their investment. This type of investors invest in fixed return instruments like Provident Funds and Bank Fixed Deposits. Some of the risk-averse investors also invest in debt mutual funds (Please read: Debt Mutual Funds-Types and Investment Philosophies). Generally experts advise the risk-averse investors to invest in debt mutual funds instead of investing in fixed deposits because of various advantages. During the current regime of interest cut, the bank fixed deposits (FDs) are becoming more and more unattractive. So, the risk-averse investors havee to explore investing in debt mutual funds to get better return. In this article, we are going to compare debt mutual funds and bank FDs. It is expected that investors may find the comparison useful and take future investment decisions accordingly.

Comparison on safety

There is absolutely no doubt that bank FDs are one of the safest investment instruments in India with almost 'Nil' chance of default. However, there have been instances all over the world and also in India that some cooperative banks and rural banks default in making payment. Bank FDs are definitely safer than debt mutual funds. However, if we take long-term perspective, we will find that the safety aspects of debt mutual funds are comparable to the bank FDs. Moreover, the mutual funds industry is closely regulated by AMFI and SEBI. So it is almost impossible for unscrupulous operators to run away with the investor's money. It can be safeely concluded that in the long term, debt mutual funds are almost as safe as the bank FDs and they give better return than bank FDs.

What about tax treatment?

So far as taxation is concerned, there is much difference between bank FDs and debt mutual funds. The returns from bank FDs are added to the investor's normal income. Needless to say that interest earned from the fixed deposits by the investors is taxable as per the tax bracket to which the investors belongs. It must be clearly mentioned that bank FDs don't get any indexation benefit. On the other hand, the debt mutual funds get indexation benefit if the fund is held for more than 36 months (Reference:Tax treatment of mutual funds in India). This means that if the debt funds are held longer than 36 months, returns are classified as long term capital gain and are taxed at 20% with indexation. So, if the investors who are in highest tax bracket (30%), definitely have more advantage in respect of tax treatment if they invest in debt mutual funds.

Position regarding liquidity

So far as liquidity is concerned, debt mutual funds are much superior to the bank FDs. The investors can withdraw the money whenever they wish from debt mutual funds. The exit load, if applicable, is for a very short period in some cases as negligible as fifteen days. On the other hand, in case of bank FDs, the money is not liquid and it take lots of complicated applications to get back the money invested. Even if the bank permits premature withdrawal from FDs, it imposes heavy penalty on the investor. So, from the liquidity point of view, debt mutual funds are much better than the bank FDs.

Most important: Comparison of returns

It can be stated without any doubt that all types of debt mutual funds (except liquid funds which aree compared with savings account) give better returns than Bank FDs, if we take one year, three year, five year and ten year perspective. The gilt funds, the corporate funds, the dynamic bond fund, the income funds have their distinctive advantages over the bank FDs. In some occasions, the difference of return is more than four percent per annum. This is the main reason why investment experts always stress upon the need to invest in debt mutual funds rather than investing in bank FDs, especially in the reducing interest rate regime.

Concluding comments

It is expected that the investors who are investing in fixed income instruments like bank FD must explore the option of investment in debt mutual funds according to the suitability. The above aspects may be kept into mind while comparing these two investment instruments for taking informed investment decvision.

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Author: DR.N.V. Srinivasa Rao19 Jul 2017 Member Level: Platinum   Points : 4

A good article. By going through the article I got good clarity on debt mutual funds and advantages in investing money there. Generally people think when you invest in debt mutual funds there is no tax advantage. But in this article the author has given the advantage of tax benefits very clearly.

One thing I want to add is nowadays the fixed deposits in banks also can be withdrawn any time as we require and the interest what we got up to that date will be credited to you. There is no penalty here. What we should remember is when we open a fixed deposit we should activate sweep-in-facility. Once you activate this facility you can withdraw your amount from bank without any loss. I have done it in HDFC bank two or three times.
But it is sure that investing in debt mutual funds is always a better option than FDs.

Author: Umesh04 Aug 2017 Member Level: Diamond   Points : 5

Today the bank FD rates are on a decline and with Govt policies going in proper direction of good tax regime and fast industrial growth there is a very good possibility that the FD rates may further go down and the post tax return on them will be in the range of 4-5 %. That may be a bad news for the persons solely managing their monthly expenses from the FD interest.

Under that situation switching to debt oriented MF schemes will be a good proposition. If one is not inclined to make heavy investments at present and go slow for debt schemes he can very well choose the SIP option in which he can gradually invest and meanwhile also monitor the progress of the industrial and GDP factors.

Author: Venkiteswaran17 Dec 2017 Member Level: Diamond   Points : 4

The statement in the article "On the other hand, in case of bank FDs, the money is not liquid and it take lots of complicated applications to get back the money invested." appears factually and practically also incorrect.

Unless it is a huge amount, premature closure of Bank fixed deposits is very easy and fast and takes very little time.

The 'penalty' is not a loss of capital or principal. It is a reduction in the interest vis-a-vis contracted interest. Mostly it is maximum one percent reduction in the interest rate eligible for the period the deposit has run till closure. There are no other penal charges with most banks.

However, like any MF, debt funds also need some time to get amount credited to the investor's account.

Author: Partha K.17 Dec 2017 Member Level: Platinum   Points : 6

Thanks to the Members who have gone through this article. Mr. Venkiteswaran has raised two legitimate issues. So far as Bank FD is concerned, I would like to clarify that I wanted to mean very big amount only. Although, normally, if an investor wants to prematurely close his/her FD, the bank immediately transfers the amount (Principal + Interest - Penal deduction of Interest) to the investor's savings account. However, in case of a large amount (more than Rs.10 lakh or so), I have noted that the bank does not immediately transfer the amount. At least, one day is taken by the bank to transfer the amount after deduction of tax on the amount. Banks are also very reluctant to pay the amount to the investor in cash at the time of premature closure of FDs.

So far as debt mutual funds are concerned, the redeemed amount is sent to the registered bank account of the investor within one working day. However, it may be noted that in case of equity mutual funds, the redeemed amount is sent to the registered bank account of the investor within three working days. Moreover, in case of debt mutual fund, there is no exit load after the stipulated period (which is usually one month or less for debt mutual funds).

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