Debt funds as a financial instrument have always been considered as a good hedge against market volatility by investors. However, the ongoing confusion over the debt funds has shaken the confidence of investors. Most investors are worried about protecting their portfolio from taking a hit in case of a market meltdown.
Fixed deposits (FDs) in such a scenario are considered as a preferred investment tool for investors to park their money. Many investors believe, fixed deposits and debt funds to be at par or FDs to be even better, with their assured returns. Both debt funds and fixed deposits at first glance may seem to be the same. However, they differ in various aspects. For instance, liquidity, risk, rate of returns, investment option, and taxation.
If you regard debt funds as the same as FDs, read on to know as to why that’s a false notion;
There is a range of investment options offered by debt mutual funds, which are classified into different types of funds, based on their investment horizon. As of now, debt funds have been put under 16 categories, and based on their need, an investor can invest in any of these categories of funds.
The categories include, low-duration fund, liquid fund, money-market fund, overnight fund, ultra-short duration fund, corporate bond fund, dynamic bond, short-duration fund, long-duration fund, banking and PSU fund, credit risk fund, floater fund, medium-duration fund, medium-to-long-duration fund, gilt fund, and gilt fund (10-year constant duration).
FDs also come in different types, regular and tax-saving. The tenure for a tax-saving FD it’s 5 years, while of a regular FD it can range anywhere between 1 to 10 years.
Rate of returns
Fixed deposits offer assured returns on their investments. These returns, however, are fixed, unlike debt funds. Debt funds, on the other hand, does not offer a fixed return. Debt funds generally invest in a range of debt securities, yet their returns are market-linked. Debt securities such as corporate bonds, government securities, commercial papers, and treasury bills.
Experts believe, even though FDs offer assured returns, debt funds have the potential to offer higher returns than fixed deposits. For instance, the 1-year average category return of liquid, overnight and ultra-short term debt fund range from 5.98 per cent to 6.85 per cent, and Gilt fund for the same tenure fetches 15.13 per cent.
On premature withdrawal, FDs charge a penalty of a certain percentage in case the investor liquidates prior to the date of maturity. Hence, if you decide to withdraw money from your FD before it matures, you need to pay a penalty. However, tax-saving fixed deposits can not be liquidated before its tenure.
When it comes to liquidity, debt funds can be redeemed. These funds are redeemed at the prevailing NAV (net asset value) on a T+1 basis. However, this also comes with a marginal exit load, which varies across fund houses.
Interest earned from fixed deposits are added to the investor’s annual income and then is taxed according to the applicable tax slabs.
In the case of debt funds, taxes are based on the term, short-term capital gains (STCG) and long-term capital gains (LTCG). STCG from debt funds, are gains that are held for up to 36 months and are taxed as per the applicable tax rates. In case of gains generated from funds held for more than 36 months are LTCG and are taxed at 20 per cent post indexation.