Why debt funds may work better for you than FDs
The rate hikes by the Reserve Bank of India (RBI) have pushed up lending and deposit rates of banks. Major banks are offering up to 7. 5% on fixed deposits of 1-5 years. Before you invest in a fixed deposit, do remember that the interest earned on bank deposits is taxed at normal slab rates. In the 30% tax bracket, the 7. 5% interest earned on a fixed deposit is reduced to just a little over 5% after tax.
If your investment horizon is more than three years, debt funds are a better alternative. If debt funds are held for more than three years, the gains are classified as longterm capital gains and taxed at 20% after indexation. Indexation takes into account the consumer inflation during the holding period and accordingly raises the purchase price of the asset to adjust for inflation. As a result, the effective tax rate for mutual fund investments is much lower than the outgo on fixed deposits.
Using Indexation Benefit
If held for longer periods, the indexation benefit is higher. If you invested in a debt fund in March 2020 and redeemed it in March 202 3, you would get the benefit of three years. But if you wait for a few days and redeem the investment after March 31 in the new financial year, you will get an additional benefit of one more year. This is why savvy investors stock up on debt funds and bonds just before the financial year ends.
Fixed Deposit interest rates high: FDs, PPF or debt MFs, which is best investment option?
Setting Off Gains Against Losses
The gains from these funds can be set off against short term and long-term capital losses on other investments. So, if you made losses in stocks or gold, you can adjust them against the gains from debt funds.
No TDS On Redemption
There is also no TDS in debt funds. In fixed deposits, if the interest income exceeds Rs 40,000 in a year, the bank deducts 10% TDS. A taxpayer who is not liable to pay tax will have to submit either Form 15H or 15G to escape TDS.
Greater Liquidity And Flexibility
Debt funds can be redeemed with the click of a mouse. When you redeem your investment, the money is in your bank account the next day. Fixed deposits can also be prematurely closed, but you get a lower rate of interest. Also, debt funds allow partial withdrawals, unlike FDs, where the entire investment is closed.