One of these alternative option to Bank Fixed Deposit is the Debt Mutual Fund. However, before you venture to these funds, it is good to know some facts about debt mutual funds.
10 things you need to know about debt mutual funds vis a vis Bank FDs
Guarantee of returns– Debt mutual funds do not guarantee returns. Fixed Deposits do. If an FD says 6% interest when you sign up, it will pay you 6%. Period. Debt mutual funds returns can vary.
Safety of Capital – Debt mutual funds take their own risks including credit risks, interest rate risks, etc, which can impact their performance. There is no capital risk with FDs except when the bank goes down.
Variety – Debt mutual funds come in a variety and you can choose one based on your time horizon and risk taking ability. There are liquid funds, ultra short term, short term, income funds, corporate bond funds, dynamic bond funds, gilt funds, etc. In case of FDs, it is plain and simple. You only have a choice of interest rate and time period.
Dividends/Interest Payout – With debt mutual funds, you can choose to have a dividend option. However, dividends are not guaranteed. With FDs, the interest payout as specified is guaranteed.
Taxation – Debt fund is treated as a capital asset. However, with recent budget changes (2023 and 2024), the gains are taxed as per your tax bracket.
Investment Insurance – Fixed Deposits are insured and guaranteed by the Government to the extent of Rs. 1 lac per bank. If the bank were to go out of business, you will still receive upto 1 lac. There is no such insurance in case of Debt mutual funds.
Investment Portfolio / Transparency – You don’t know what happens in a Fixed Deposit or how is it managed. Neither the associated costs. In case of a debt mutual fund, the exact portfolio is disclosed on a monthly basis as well as the costs of doing the same.
Market driven – There is no market value to an FD. You have a principal amount which you invest and you earn interest on it. The debt mutual fund has a market value calculated in the form of its daily Net Asset Value or NAV. This value can go up and down.
Interest rates and prices – There is an inverse correlation between bond prices and interest rates. So, if the general interest rates in the economy go down, prices will go up and vice versa. Debt funds are affected by this and it reflects in their prices or NAV. This may make the value of the investment to go up and down too. With FDs, once you have fixed your interest rate, it is assured to you till the maturity.
Premature withdrawal – With Fixed Deposits, there is usually a penalty on premature withdrawal such as lower interest by 1%. In case of most open ended debt mutual funds, there are no penalties at all. You can take your investment back any time as per the current market value at that point in time.
Growth chart of Debt mutual fund – Liquid fund
Above, a liquid fund displays a consistent growth as it invests in very short term instruments. The interest rate risk is limited or non existent here. Such funds do not try to anticipate or invest based on interest rate movements.
Growth chart of Debt mutual fund – Dynamic Bond fund
A dynamic bond fund tries to anticipate interest rate movements and manages its investments accordingly. This adds risk to the investment and can lead to volatile movements in value. See the curve going up and down at various points over the last 3 years.
So, are debt mutual funds for you?
If you are in the lower or zero tax bracket and you prefer certainty of capital and returns, FDs is still the option for you. Remember though that inflation is eating into your investments.
But for those who are in the higher tax brackets, it might make sense to look at debt mutual funds for your asset allocation.
Having said that, it is advisable that for money that you need within 5 years, it should be invested in FDs or debt mutual funds.
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