Among all the fixed-income investment avenues, fixed deposits are the most popular. They are unaffected by market fluctuations, offer high liquidity, and guarantee returns.
But you cannot generate long-term wealth with fixed deposits alone. Of late, interest rates on FDs have been at multi-year lows because of rising inflation. In this scenario, debt funds have emerged as another popular fixed-income investment tool.
Debt funds are a type of mutual funds that invest your money in fixed income instruments like government and corporate bonds, treasury bills, deposit certificates, etc. Like all funds, they are subject to market risks. So, many risk-averse investors may choose FDs over them.
As an investor, where should you put your money? To help you decide, here is a comparative analysis of debt funds and fixed deposits.
Returns in debt funds vs fixed deposits
When you create a fixed deposit with an NBFC, you deposit a lump sum amount, decide a tenure, and earn interest on the amount during that period.
When you put your money in a debt fund, the fund manager uses it to buy fixed-income securities, such as bonds, and earn interest income. So, the returns you get from a debt fund come from the interest income.
Debt funds typically invest in a variety of bonds whose prices rise and fall depending on interest rates in the economy. The amount of interest paid on a bond is fixed. But if the price of a bond rises, your debt fund can return additional money over the interest income.
Additional Read – Mutual Funds VS Fixed Deposit : Which One Should You Choose?
Comparing short-term and long-term returns
FDs, especially cumulative FDs, work well in the long term. You can set your FD to get auto-renewed and earn compound interest.
Debt funds are best for short and medium-term investment plans because they do not perform optimally in the long term. To meet your short term and medium-term needs, you can choose debt funds that have a tenure ranging from 6 months to 2 years.
Comparing other important features of debt funds vs FD
|Fixed deposits||Debt funds|
|Risk||Fixed deposits are an extremely low-risk investment option.||Debt funds offer low to moderate risk. They are much less risky than equity funds.|
|Taxation||Interest earned is added to your taxable income. If the interest is more than Rs. 10,000, 10% TDS is applicable.|| Short term capital gains (holding period less than 3 years) are added to your taxable income and taxed as per your tax slab.|
Long term capital gains are taxed at 20% with indexation.
|Investment option||Can only invest a lump sum amount.||Can invest lump sum or through SIP.|
|Early withdrawal||A penalty is charged for premature withdrawals||Small exit load charges (if applicable) and expense ratio are applicable.|
Additional Read –Everything you need to know about Value Investing
Which one should you choose?
If you want to achieve your short or mid-term financial goals, you should invest in debt funds. You can also choose debt funds to diversify your portfolio. You can start investing in debt funds in just a few days with Tata Capital’s Moneyfy app.
Moneyfy gives you fund recommendations based on your goals and risk profile. So, download the app today and complete the online KYC.