Often, a bank fixed deposit is an initial port of contact for many investors beginning their investment journey. However, increasing awareness surrounding mutual funds has enticed many to invest in debt funds to earn higher returns than fixed deposits.
While debt mutual funds may not provide assured returns, they tend to outscore fixed deposits on one of the important factors i.e., taxation. Discussed here are how debt funds are better than fixed deposits on aspects like return, liquidity, taxation, etc.
The distinction between bank fixed deposits and debt mutual funds –
A fixed deposit is an investment where you invest a lumpsum amount with the financial institution for a fixed time period. In exchange, you earn interest that is predefined. You can make an investment in a fixed deposit for a tenure of up to 10 years. Debt fund, on the contrary, is a kind of mutual fund managed by the AMC (asset management company). When you make an investment in a debt mutual fund, your money gets invested in the debt papers of the PSUs, private companies, government bonds and others. Moreover, there aren’t any specific maturity dates for such instruments too. You can exit and enter at any time. Thus, as debt funds are market-linked, all well-managed debt mutual funds typically deliver better returns as compared to fixed deposits.
Fixed deposits and debt funds – Taxation rules
While debt funds and fixed deposits are debt investments, there are very few distinctions in the manner both are taxed. The initial and perhaps the most basic distinction is when are the returns on these instruments taxed. In the case of fixed deposits, the interest earned on them is subject to tax in a financial year. In fact, all interest generated from fixed deposits in a year must be declared in your IT return under the “income from the other sources” head. In contrast, debt mutual fund returns are taxed when you redeem them. It is known as deferred tax treatment.
So, for the holding period of below 3 years, there’s zero difference between how the fixed deposit and debt mutual fund taxation functions. The returns get included in your income and taxation takes place according to your income tax slab. In case you hold the debt funds for over 3 years, while fixed deposit taxation stays the same, debt fund taxation rules are different. If you liquidate your debt mutual fund investments after holding them for 3 years, the gains on it get classified as LTCG (long-term capital gains). LTCG is taxed at 20 per cent after indexation.
Ending note
As an instrument to preserve wealth, a fixed deposit is a prudent instrument because it endows benefits such as minimal risk and assured returns. However, in the case you are looking to book a fixed deposit for over 3 years, it may be a prudent idea to rethink and instead invest in debt funds. This is because, opting for long-term debt instruments will considerably lower your tax liability, particularly if you fall in the highest 30 per cent tax slab. Additionally, by investing in debt mutual funds, you would earn a higher return as compared to fixed deposits.
