SENSEX NIFTY
Nov 16, 2011, 12.26 PM IST | Source: Moneycontrol.com

Advantages of debt funds over fixed deposits

When it comes to investing in fixed income instrument, it is always better to invest in debt funds than fixed deposit. Financial advisor PV Subramanyam tells you why.

Advantages of debt funds over fixed deposits

What are the options that a person has when he/ she chooses to invest in a debt instrument?
Well the choices are:

1. Bank fixed deposit – requires very little explanation.

2. Company fixed deposits – not a big range of companies available, but a good option.

3. Company Bonds – Right from Tata to Sriram and Indiainfoline have listed debentures.

4. Government / Post office schemes – Google and you will find the details.

5. mutual funds.

There are too many people who think mutual funds mean ‘Equities’. Well, it is not so, you can invest in a mutual fund – and choose a debt scheme also! Here I am planning to write about mutual funds – why and what kind of schemes to choose from.

I am too dumb (ok not clever) to know anything about interest rate cycles – and I am yet to meet somebody who is a good debt fund manager. So without wanting to risk playing the interest rate cycle, let me choose a fund which chooses assets of 6-24 months duration. Here the duration risk is dramatically reduced – though some pundits may argue that we are at the higher end of the interest rate cycle. If you honestly believe that, you can put your money in a gilt fund or a dynamic bond fund.

Like I said, I am yet to meet a ‘smart’ debt fund manager, so I will play the game by my rules.

What are the advantages of a debt fund over a fixed deposit?

I asked 4 fund houses for an answer – one fund house had a good conversation about it, but no answer. One fund house sent me a completely irrelevant power-point presentation (did not have the heart to send it to the MD who is knowledgeable), one fund house has still not sent anything, and one fund house has not bothered to get back.

Most fund houses (and therefore the distributor) will send you a presentation on bank fixed deposit vs. Fixed Maturity Plan (FMP).

I am talking of a Bank Fixed deposit vs. Mutual fund Income scheme.

Let us look at the advantages of a mutual fund:

1. The single biggest advantage is you can choose how much to deposit and how much to withdraw.

2. You pay taxes only when you withdraw.

3. You can use it like a savings account – put money whenever you want and withdraw when you want.

4. Even with interest rate cycles there is a good chance that you will get a decent return.

Historically it is easy to argue that very few debt mutual fund schemes have outperformed bank fixed deposits especially over long periods of time. This is right, but still, post tax the mutual fund returns are likely to be superior.

Click here to know the list of debt schemes

What makes an Income Fund (Growth Option) attractive?

Well the deferred tax bit!

In a bank fixed deposit of say Rs. 10,00,000 you will get a return of Rs. 100,000 if the interest rate prevailing is 10%p.a. However on this Rs. 100,000 you will pay income tax of say 30% - assuming tax at the higher end of the slab.

In a mutual fund assuming the same returns your GROWTH option NAV will be Rs. 11 – i.e. your accumulation will be Rs. 11,00,000. Now if you did not need even one rupee out of this, THE WHOLE AMOUNT OF Rs. 11 lakhs is available for compounding in the next year.

Thus the amount available for compounding in case of a bank fixed deposit is 10,70,000 and it is Rs. 11,00,000 in case of a mutual fund. Now if you do this over a 15 year period – the impact is HUGE.

Thus let us say a 44 year old man who has a surplus of Rs. 10,00,000 – and has a high current income (which means he will not need the income from this Rs. 10 lakhs) should invest this amount in an income fund and leave it there till his age of 65!

What would have happened?

  • His corpus would have grown for 21 years without any interruption
  • Tax would be paid at the end of the period
  • The tax would be indexed capital gain instead of regular income tax
  • He could have added regularly without any worries
  • In a worst case scenario he could have withdrawn a small portion of the amount and paid a little tax.
Why is it that mutual fund distributors are not really pushing such schemes? My guess is old habits of pushing equities die hard!

-PV Subramanyam

The author is a Chartered Accountant by qualification, a trainer and runs subramoney.com

Q Who owns a mutual fund?

ADS BY GOOGLE

video of the day

Auto, bank to do well; L&T good 2-3 yr story: Alchemy's Ved

Explore Moneycontrol

Copyright © e-Eighteen.com Ltd. All rights reserved. Reproduction of news articles, photos, videos or any other content in whole or in part in any form or medium without express written permission of moneycontrol.com is prohibited.