Debt Funds Vs Fixed Deposits Benefits & Risk
What are debt funds
Debt funds invest your finance in fixed income securities like government securities, debentures, corporate bonds and other money-market instruments. By investing in such different securities the investors portfolio becomes well diversified, therefore leading to lower risk of losing the invested finance.
Benefits of investing in a debt fund
Stability
Investing in debt funds can increase the balance of your portfolio. Equity funds, while offering high returns, can be fairly volatile. However, apart from one or two types of debt funds, most of the other debt funds are very safe and with minimal risk.
High liquidity
Unlike Fixed Deposits, the Debt funds can be easily withdrawn from the financial institution. In the case of Fixed deposits; if a FD has to be liquidized pre-maturely, a penalty has to be paid by the investor to the financial institution. This occurs because the money has been withdrawn before the lock-in period has ended. This problem never arises if the finance was to be invested in Debt funds, since Debt funds do not have a lock-in period.
Tax efficiency
Many people invest money for the prime reason of reducing their annual tax outgo. So, if tax reduction is a crucial investment goal, you can consider investing in debt mutual funds. This is because debt funds are more tax-efficient than traditional investment options like fixed deposits (FDs).
In FDs, the interest you earn on your investments is taxed each year based on the income slab for which you are eligible irrespective of the maturity date being in that year or later. In case of debt funds, you pay tax only in the year you redeem and not before that. You also pay tax only on the redemption proceeds, even if is a partial redemption. You pay Short Term Capital Gains (STCG) tax if you hold your mutual fund units for less than three years and Long-Term Capital Gains (LTCG) for investments beyond three years. LTCG are eligible for indexation benefits wherein you are taxed only on the returns which are over and above the inflation rate(embedded in cost inflation index {CII}). This helps to reduce your tax outgo as well as provides better post tax returns.
What are Fixed Deposits
A fixed deposit, or an FD, is a financial instrument offered by banks or NBFCs (Non-Banking Financial Company) that provides investors a higher rate of interest than traditional savings’ accounts. Since investors are promised a fixed rate of return, which are set by the banking regulator Reserve Bank of India (RBI), FDs are a safer investment option. In return, the investor agrees not to exit or withdraw the funds for a given period.
Benefits of investing in Fixed Deposits
Zero-Risk Saving
A fixed deposit promises guaranteed returns and carries minimal to no risk to the investor. Preferred by most investors for its zero-risk, it is a great starting point if you wish to start saving. With an FD account, you can start putting aside your savings while it also helps you earn a guaranteed rate of interest. The announcement in the Union Budget 2020 about increased insurance of Rs 5 lakhs by the DICGC (Deposit Insurance and Credit Guarantee Corporation), RBI has made it even safer. This same limit was up to Rs 1 lakh until now.
Easy Liquidity
While they are safe, liquidating your deposits is easy as well. Most FDs barring, tax-saving FDs can be withdrawn prematurely by paying a small penalty. Moreover, the process is quick and easy. You can close your FD online using your bank’s net banking portal.
Tax-saving Option
Under section 80C of the Income Tax Act, fixed deposit investors can deduct up to 1,50,000 against the investment made from their taxable income in a year. This makes it a great tax-saving tool while helping you earn guaranteed returns. However, the tax-saving deposits come with a mandatory 5-year lock-in period and cannot be withdrawn before that under any circumstances.
Conclusion
All in all, the investment will solely be based on the goal of the investor. If the investors want quick returns with lesser chances of a penalty being levied, then they should go invest their money in Debt Funds. However, if investors want to play a long term game, where they want to secure their future earnings, they should invest their money in Fixed Deposits.
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