For decades, fixed deposits have been the instrument of choice for low-risk investors. This preference is easy to understand as fixed deposits provide a guaranteed return at maturity. However, many investors are turning to debt funds over the years. Especially, since demonetisation in 2016, mutual funds caught the attention of various investors and rose to prominence.
If you are new to the world of mutual funds and wondering what are debt funds, they are types of mutual funds, which invest primarily in a mix of fixed income securities. These securities include treasury bills, money market instruments, government securities and corporate bonds.
Let us look at the differences between fixed deposits and debt funds and the benefits of investing your excess money in debt funds.
Fixed deposit v/s debt funds
- Rate of returns
Debt fund returns are based on the overall interest rate movement. Typically, interest rates range between 7% and 9%. On the other hand, banks offer a pre-set interest rate for fixed deposits depending on the horizon. These interest rates generally fall in the range of 6% to 8%.
- Dividend option
In debt funds, you can get regular income by choosing the dividend pay-out option. Fixed deposits do not provide dividends.
Debts funds carry a low to moderate risk. They invest in a mix of fixed-income securities or debt. Whereas in the case of fixed deposits, the risk factor is low as returns are assured and unaffected by market fluctuations.
Some circumstances may require emergency funds. Debt funds serve as the ideal instrument to park your funds as an emergency reserve. They can be redeemed at will, unlike fixed deposits which have a mandatory lock-in period and provide no liquidity.
- Penalty on early withdrawal
Debt funds allow early withdrawal with or without the exit load, depending on the type of mutual fund. On the contrary, if you withdraw the amount from fixed deposits before maturity, you are charged a penalty by banks or financial institutions.
- Investment option
To invest in debt funds, you can either choose the SIP option or make a lumpsum payment as a one-time investment. In the case of fixed deposits, you only have the option to make a lumpsum investment.
If you have invested in debt funds for a short term there is no difference between the tax rates of fixed deposits and debt funds. They are both taxed as per your individual tax slab rate. However, for long-term gains, the tax rate is 20% with the benefit of indexation.
Benefits of investing in debt mutual funds
The main goal of a debt fund is to provide steady returns throughout your investment horizon. Here are some more reasons why it is beneficial to invest in debt funds.
- Debt mutual funds have the potential of pacing with inflation, despite the risk. They are likely to deliver a higher return as compared to other traditional forms of investments.
- Open-ended debt fund proceeds can be credited to your bank account within a few days depending on whether an Electronic Clearing Service mandate is registered.
- Debts funds can be the best option of lending stability to your investment portfolio through diversification.
You can get better returns if you utilise the excess money in your bank account to invest in debt funds. Before you invest in mutual funds, you may want to research and choose the right fund to get the best deal possible to meet your financial objectives. Consider taking the help of professionals to make the right choice if you are unsure.