Are Debt Funds Better Investments Than Bank Fixed Deposits?

Are Debt Funds Better Investments Than Bank Fixed Deposits?

The answer is yes, 100% debt-oriented mutual funds, that hold a diversified portfolio of  top-rated company debentures and government bonds, are indeed better investments than bank fixed deposits.

The FIIs know this. They have poured in billions of dollars into the Indian debt market to access some of the highest risk-free returns in the world, at 8% or more, before deducting taxes and discounting the exchange risk.

Debt mutual funds now come in a wide array of choices: liquid funds that invest in very short-term debt instruments, just three-months; others at short, medium, and long durations, ranging from six months to 10 years.

All debt funds, even the ‘close-ended’ ones, with a 3 year lock-in, are diversified, to contain between 10 and 20 different debt instruments. This is also in keeping with the regulatory environment, created by SEBI, mandated to protect the interests of investors.

The open-ended debt mutual fund is the best option, because it can be bought or sold on any working day, with pay-outs within just three working days.

All debt funds are tax efficient, because they are capped at a tax rate of 20% at present, and have inflation indexing benefits, if held for three or more years. 

Quite often, this means the taxes calculated eventually are either minimal, or nil.

If, however, any portion of the investment is withdrawn for any reason within the three years, only the profits will be clubbed with the holder’s other income, and taxed at the applicable rate. It is also permitted by the RBI to pledge these debt funds freely to any bank, and borrow up to 90% of their value.

The scores of debt mutual funds, are all rated by CRISIL ,Value Research, Economic Times, Moneycontrol, etc., provided they are 3 years or more old.

These star ratings and their logic, even for those funds that are not yet mature enough, are all freely researchable on the Internet. And though there are many financial advisers, both with the banks and elsewhere, it is quite possible to invest directly, thereby saving on brokerage and commissions.

A good thing to remember is that debt funds tend to do well in a declining interest rate scenario, and unlike bank fixed deposits, tax-free bonds, or company deposit schemes, benefit from macro-economic trends. Picking the right one could deliver double-digit returns with safety.

Bank deposits, conversely, only pay a predetermined amount of interest. And even this, after locking in the principal for a duration, and deducting TDS, is fully taxable.

The RBI has cut interest rates by 125 basis points (1.25%), over the last two years.  The new governor, taking charge after September, is expected to cut interest rates further. Though a cut could come even earlier, in August, when the next review is due.

This, on the back of the good monsoon underway. The rain is expected to foster higher farm incomes, and quell food inflation as well. But will it raise bank fixed deposit interest rates? The answer, unfortunately, is no.

For: ABP Live

(500 words)

July 5^th, 2016

Gautam Mukherjee