As times change, everything evolves along with, the only constant is change. Bell bottom pants of the seventies have been replaced by low waist jeans, the Cadillac’s have made way for the Porsche’s, Smartphones and tablets are the new age communication and information devices. But when it comes to investing people still can’t think beyond Fixed deposits (FD’s). Statistics show that more than 80% of investments made by general public are through FD’s, this inspite of other available debt saving options which are equally risk free and giving better post tax returns.
If you are worrying about falling interest rates leaving you with no fixed income options, you are right, if your only fixed income option is bank Fixed Deposits (FDs). But did you know that falling interest rates can actually be a great opportunity in the debt market?
Traditional fixed deposits are preferred over any market linked investments. This is mainly due to the security of investment and assured returns. Debt funds also come with a lot of benefits and are meant for risk averse investors who do not prefer to invest in equities. However, should one put aside some money to invest in Debt Funds? Let’s have a look at how Debt Funds compare with Fixed Deposits.
Returns
Fixed deposits almost always have a fixed rate of interest that you will earn on your deposit. Whereas debt funds do not come with the promise of assured returns.
Tax
The entire income from FDs is taxable at the slab rates applicable to you. However for debts funds based on the change in the Budget of 2014 are considered as Long Term Capital Assets when held for more than 36 months. Which means, if you hold them for more than 36 months, you can get the benefit of indexation of the cost and your capital gains (if any) after applying indexation shall be taxed at 20%.
Let’s see that with an example – Suppose Garima who is in a 30% tax bracket invests Rs1,00,000 in a fixed deposit in Dec 2012. She holds the FD for 3 years and earns an interest of 9% each year. Her total Interest Income shall be Rs 9,000 in the first year, Rs 9,810 in the second year, Rs 10,693 in the third year using compounding. Totalling to Rs 29,502. On which she shall be liable to pay a tax @ 30% = 9,116 [Rs 8,850 (basic Tax) + 265(3% cess)]. Her net gain = Rs1,29,502 – 9,116 = Rs 1,20,386.
If Garima invests Rs 1,00,000 in Dec 2012 in a debt fund that gives 9% interest. In this case the value of her investment after one year shall be Rs 1,09,000, Rs 1,18,810 at the end of second year and Rs1,29,502 after 3 years. Since the investment is made for 3 years cost shall be indexed and therefore using the cost inflation index for the years 2011 & 2014 her indexed cost works out to Rs 1,00,000 *1024/785 = 1,30,445. This actually results in a capital loss for Garima. Although her returns in terms of percentage are the same as compared to Fixed Deposits. She doesn’t pay any tax on the gains.
Tax Deduction at Source (TDS)
Interest exceeding Rs10,000 earned by you on Fixed Deposits is subjected to TDS by the bank every year even though you may not have received any interest TDS is deducted on accrual basis. No TDS is deducted on returns from Debt Funds. Any tax applicable on a debt fund arises only on maturity and not during the time you hold the fund.
Learning
Debt funds when held for more than 3 years are more tax efficient and can give better returns that Fixed Deposits. However like any other investment, Debt Funds must be purchased after full review of the fund house and the fund’s performance.
