Why Bank FD Interest Rates Can’t Match Debt Mutual Fund Returns | Jobs Vox


Indian investors cannot have enough fixed deposits. According to Crisil, nearly $170 million is lying in bank deposits across the country, which is more than the combined investments of Rs.135 lakh crore in mutual funds, life insurance, pension schemes and alternative investment funds. The study shows that while the share of bank deposits in total savings has declined, they still account for the largest pie of household savings (
See the graphic).

The gargantuan amount in bank deposits is set to grow further. Banks hiked their deposit rates following the RBI’s repo rate hike. SBI increased its deposit rate by up to 65 basis points and HDFC Bank by up to 75 basis points. Many smaller banks have raised rates and other major banks may follow suit.

However, before you invest your money in fixed deposits, remember that the interest earned on these deposits is taxable at the standard rate applicable to you. In the 30% tax bracket, the 7% interest earned on fixed deposits would be less than 5%.


Low tax rate, no TDS.

For investors, the best option is to go for debt funds. Profits from these funds are also taxed, but at different rates. If held for less than three years, the profit will be taxed at the same rate as bank deposit interest. But if you invest for more than three years, the profit from debt funds will be treated as long-term capital gain and will be taxed at 20% post-indexation. Indexation takes into account consumer inflation at the time of the mortgage and accordingly increases the purchase price of the property to adjust for inflation.


Suppose you invested Rs 1 lakh in a debt fund three years ago and got 7.5% compounded return, the inflation index has increased by 15% in three years. The purchase price of the property will be revised to Rs.1.15 lakh (see graphic), which will reduce the profit and tax. But interest earned on fixed deposits will not get any indexation benefits. Experts say that high inflation is to stay for some time, which means that the indexation can bring the effective tax significantly.

As the yield to maturity for most debt funds is around 7-7.5%, the pre-tax return on debt funds is no different from bank deposits. But it seems unlikely that interest rates will go any higher. If interest rates fall, debt funds can offer higher returns. The longer you hold a debt fund, the bigger the index benefit.

That’s why savvy investors spend their time on indexing their investments to get the most out of them. Moreover, the gains from debt funds can be offset against short-term and long-term capital losses that you have incurred on other investments. There is no TDS in debt funds. In fixed deposits, if your interest income exceeds Rs 40,000 per annum, the bank will deduct 10% of this income. A non-liable taxpayer needs to file Form 15H or 15G to avoid TDS.

More liquid than deposit

Debt funds are very liquid – you can withdraw your investment at any time and the money is in your bank account the next day. Some fixed deposits can be withdrawn prematurely, but you will get a lower interest rate. Also, when you close a fixed deposit prematurely, the entire amount will be withdrawn. But debt funds allow partial withdrawals without breaking the entire investment.

Also, in some cases, the process of liquidating a fixed deposit requires more paperwork than a mouse click. Another key benefit is the transferability from debt funds to any mutual fund house. Investors can make periodic withdrawals in an institution that is particularly useful for retirees looking for a steady monthly income. The withdrawal amount can be changed at any time.


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