- Date : 25/08/2022
- Read: 4 mins
Two primary reasons mutual funds’ benefit outweighs bank fixed deposits. They are tax efficiency and inflation adaptability.
Fixed Deposits have been a part of Indian households for a long time. They are undoubtedly trusted and reliable, sometimes even blindly so. Our elders have trusted fixed deposits for long-term capital gains with maximum protection. With a decided interest rate, it offered stability while we continued earning the extra money.
But in recent times, we have seen rapid growth in investment in mutual funds. It has led to the downfall of investment in FDs. This sharp rise happened after the government’s demonetization in 2016. During this stage, the return rate of the fixed deposits was lowered, and the mutual funds swept in with high-interest rates.
Mutual fund vs. FD: a comparison
- Rate of returns: The fixed deposit returns range from 6%-8%, whereas the mutual fund return ranges from 7%-9%.
- Risk factor: The risk factor for mutual funds depends on the market. It has a moderate to high-risk chance. FDs have a low-risk factor barring only economic inflation.
- Liquidity of your amount: Mutual funds offer a high liquidity option. Some FDs have low liquidity options.
- Dividend option: Mutual funds come with a dividend option, but fixed deposits do not.
- Type of investment: For mutual funds, you can opt for a SIP investment or a one-time investment. In fixed deposits, you can only go for a lump-sum investment.
- Premature withdrawal: Depending on the type of mutual funds, an exit load might not be applied to your withdrawal. In the case of FDs, if you opt for an early withdrawal, a penalty is levied.
- Investment Expenditure: A nominal expense ratio is charged in the case of mutual funds. But in fixed deposits, no such management costs are applied.
Also Read : How liquid funds are better than FDs.
Is mutual funds a good investment? Let us see how.
1. Tax Efficiency
Taxes are applied to your investment interests in fixed deposits. The extra cash you get is added to your taxable income depending on which income tax slab you fall in. Mutual funds, on the other hand, save more tax than bank FDs.
The returns from debt mutual funds for a short period (upto three or fewer years) are known as short-term capital gains or STCG. This short-term gain is taxable like the bank FDs and is added to your income tax slab.
However, if your debt mutual funds’ investment is for more than three years, it automatically becomes a long-term capital gain or LTCG. While LTCG is also taxable, it is only taxed at 20% and has the benefit of indexation. This makes it more tax saving than long-term fixed deposits of banks.
However, if you invest in equity mutual funds, its returns are considered LTCG after only one year.
Thus, mutual funds are more tax saving if the investor falls in the higher income tax slab and has plans for investing for more than three years at least.
2. Inflation adaptability of mutual funds
It is a well-established fact that economic inflation harms your savings, resulting in the loss of currency values. Though they might have risks, mutual funds can keep up with inflation. If you have a fixed deposit with an interest rate of 6% and the economic inflation is at 5%, the returns will merely be 1%. Mutual fund returns, on the other hand, will be relatively higher. Let us see this example for a better comparison.
Let us assume you have invested a sum of Rs 2,00,000 in both mutual funds and fixed deposits. The period to hold the amount is for three years. The return rate for these investments is 7%. You are expected to receive Rs 2,45,000 from both investments at the end of three years. Mutual funds provide you with an indexed cost of acquisition which leads to a sum of Rs 2,20,472. No such privilege is available in fixed deposits. The amount taxed in mutual funds comes out to be Rs 24,528, while in the FD, it will be Rs 45,000. Assuming that the tax bracket is 30%, for your mutual fund, you will only have to pay Rs 4906 (because the tax rate is only 20%). As for your fixed deposit, you must pay Rs 13,500 as taxes. Your income tax return after the deduction of taxes is Rs 40,094 for mutual fund and Rs 31,500 for fixed deposit.
Also Read : top 10 mutual funds to invest in 2022.
You should consider your ability to take risks, your income tax slab, the time you can give your investment to grow, and your plans for your money. Mutual fund analysis shows that it can offer better returns than bank fixed deposits, especially after-tax returns. But the market risk of mutual funds still stands in the way and should be considered. To make a proper and informed decision, you must consult a trustworthy mutual fund advisor or a planner.