Before we talk about which instrument, debt funds or fixed deposits, to invest in 2023, it’s critical to gain some context on how yields or interest rates on these two instruments work.

Keep this thumb rule in mind that when interest rates hike, debt fund NAV goes down. However, contrary to debt funds, the ROI on fixed deposits go up with a hike in repo rates. Anyway, financial institutions have a certain amount of freedom when it comes to deciding their FD rates. Now, why these things happen is a question for another day.

But this is precisely why the year 2022 witnessed a lacklustre performance by debt funds. The RBI had started increasing their repo rates during this time for the first time since after the pandemic.

However, the soaring interest rates of 2022 are finally about to hit their peak in 2023, which is precisely why debt funds have once again become an attractive asset class. The market sentiment is over the uncertainty of increasing interest rates. And, once they peak, the NAVs of debt funds will stabilise and offer considerable returns.

So, Should I Pick Debt Funds over FDs?

Nobody denies the benefits of investing in fixed deposits, be it in 2023 or any other year. This fixed-returns instrument offers portfolio diversification and much-needed income stability. But you must only invest a part of your corpus in fixed deposits. And, if you have already done that, it makes a tonne of sense to invest in debt funds over fixed deposits in 2023.

Here’s why:

  • Firstly, even though RBI has increased its repo rate, most financial institutions are yet to pass this benefit to investors. This means FD rates aren’t as high as they should be, and certain debt funds are offering higher returns.
  • Secondly, and more importantly, fixed deposits don’t feature the same tax benefit as debt funds do. Unless you invest in tax-saver FDs with a 5-year lock-in, your FD ROI is taxed as per your income tax slab. This can go up to even 30% depending on your salary or profit.
  • On the other hand, returns from debt funds are classified as short-term capital gains and long-term capital gains and carry indexation benefits. While short-term capital gains are calculated as per your income tax slab, long-term capital gains (earned after 3 or more years) are taxed at 20%, but with indexation. This indexation benefit brings down the effective tax below 20%.
  • Add to it, any long-term gain up to Rs. 1 lakh is entirely tax-free.

The Final Verdict

As mentioned above, we are nearing the peak of repo rate hike cycles. Shortly enough, the rate hike will flatline and remain there. They may even start coming down. This will and is already leading to the elimination of any negative impact on debt funds, which is why they have begun performing well, better than FDs in terms of returns.   

Therefore, during such a time, you should consider debt funds, especially target maturity funds.

What are Target Maturity Funds?

These funds are passive debt funds tracking underlying debt index. These indices primarily invest in instruments, like G-securities, PSU Bonds, Corporate Bonds and State Development Loans, based on an underlying index such as NIFTY PSU or Nifty SDL. Structurally, these funds are similar to ETFs or index funds as they mirror the indices they align to.

The primary difference is that target maturity funds have a pre-defined maturity date, which is clearly stated in the scheme document. Simply put, you stand a high chance to earn substantial interest along with the principal amount at a fixed date.

The top three benefits of target maturity funds include:

1. These funds are less volatile as they hold bonds until maturity and duration reduces with time. This investment option is especially beneficial in a soaring interest rate scenario.

2. They offer considerable flexibility to investors as they come with a variety of tenures. Investors can choose one based on their desired investment horizon.

3. They offer better tax benefits than fixed deposits.

Need More Advice?

Turn to Tata Capital Wealth. Allow our seasoned financial experts to evaluate your risk tolerance and craft a bespoke investment strategy that grows your wealth in the short and long term. From understanding your financial psyche to helping you select the right financial products, we are with you every step of the way.

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