The debate between Debt funds vs bank deposits is still on and Debt funds are frowned upon these days. The reason is not only the high equity returns, which are coming in double digits but also the tax rules, which were changed last year. As per the latest tax rules, the returns in debt funds will be taxed according to the income slabs, and all gains will be considered Short-term capital gains irrespective of the holding period.
This is why investors nowadays consider Fixed deposits over Debt Mutual funds, citing taxation as the reason. Fair Point.
But was taxation the only advantage Debt mutual funds provided over fixed deposits? The answer is NO. However, lower taxation was one of the USPs. If used smartly, debt funds can provide other numerous benefits too.
This article is to share the Benefits Debt funds still offer compared to bank deposits, and how best investors can make use of the available debt mutual funds structure.
Debt funds vs Bank Deposits – What may suit you best?
- Tax deferment – Debt funds still offer tax deferment if not tax saving compared to bank deposits. This is because the gain in the debt funds is not taxed on accrual unlike FDs, but only on Withdrawal/Redemption. Also, if you do the partial withdrawal (which is also not available in Fixed deposits) only the gain booked on sold units will be taxed.
E.g. You invest Rs 10 lakh in Bank FD and the same amount in a debt mutual fund. Assuming both generate income of 7%, which translates to Rs 70000/-. In the case of bank FD, Rs 70000/- will be added to your total Income in the year of earning/accrual, whereas in debt mutual fund the gain will not be added until you redeem your Mutual fund units. (Also read | Why Simple is Better: Understanding Complexity Bias)
And there could be times if you plan the withdrawal well, you can do away with taxation completely (explained in the next point)
- Tax Transfer – Say you are saving for your kid’s education, and decided to move money from Equity to debt schemes when nearing the goal. This is to keep the goal amount safe from volatility. But here rather than reinvesting the equity proceeds in your name, you invest the same in your kid’s name.
Or from the very beginning, you keep investing the debt allocation in your minor children name to be withdrawn after they turn 18, for their higher education.
In both these cases, there will not be any clubbing of income applied, which would have been had the investment been in Fixed deposit. Also, when your kids turn major and then withdraw money the taxation will fall in their name, and assuming they don’t have any income then, they will get their Income tax slabs advantage, on the capital gains booked. (Explore | A Tale of a Confused Investor | From Fund Selection to Professional Advice)
- Systematic Transactions and Switching – When you have a well-allocated portfolio with a mix of equity, debt, and gold, it becomes easy and fast to average the market volatility through Systematic transfers, and also keep watch on the overall asset allocation and do the rebalancing whenever required, which you may not if you have money lying in FDs or even bank accounts, as that may take some time to transfer and reassess.
Generating Regular and even growing Passive income is much easier in mutual funds than in bank deposits ( discussed in the last point)
- Short-term Parking – Debt funds start adding returns from day one of investments. Depending on the category of scheme it does not need any minimum period of deposit, unlike bank fixed deposits. Also, the rate of return does not come with Slabs. This is why business people park their current account money into Liquid or ultra-short-term funds to earn some return on their otherwise idle money. Retail Investors may explore less than 1-year parking of funds in Debt funds. (Also Read: Tax efficient alternative to debt mutual funds)
- To generate Regular Income – When there is a question about generating regular income or creating a structure for passive income, Debt funds score better over Bank deposits. Systematic withdrawal plans, and partial withdrawal facilities, take care of the Liquidity needs of the Investor. You need not block your money in a fixed period to start getting the interest. This feature is commonly used in the Bucketing approach of retirement planning.
- High returns during Falling Interest rates: The debt mutual funds give high returns in the falling rate scenario. This is due to the inverse relationship between Interest rates and bond prices and also due to the active management of bonds by the funds Managers. So in such a scenario, your post-tax returns will always be better than bank deposits.
- Best for NRIs – Though NRE Fixed deposits are Tax-Free for NRIs, if they don’t have any other income in India, then they can make good use of debt mutual funds by investing and booking the gains every year. Since the gains in debt funds will be added in the income and taxed as per slabs and when you don’t have any income in India, you can very well take advantage of the slabs and make your short-term returns tax efficient.
Conclusion:
Debt Mutual funds are wonderful products if used wisely along with other asset Classes. I agree that indexation was a great advantage, but we should not look at every investment only from the taxation side. We can create a well-diversified and structured portfolio to optimize risk and return, by taking advantage of market movements and also generate regular tax-efficient income arrangements from debt mutual funds.
What do you think? What will you Prefer Debt funds Vs Bank deposits? Do share your views in the comments.
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(Read: Did your Mutual fund Investment deliver a 100X return?)
