If you were to compare these investments– Debt Fund vs FD, which one would you choose?
You can invest in both Debt Funds and Fixed Deposits (FDs) when it comes to choosing safe and stable investment options, but which one is better. In this blog, we shall understand what debts funds and fixed deposits are and how knowing their differences can help you diversify your investment journey.
What is a Debt Fund?
A Debt Fund is a type of mutual fund that invests in fixed-income securities such as bonds, government securities, and corporate debt. Debt Funds offer market-linked returns and are considered safer than equity mutual funds.
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What are the Features of Debt Funds?
Here are the important things to know about debt funds and their characteristics:
1. Market-Linked Returns
The returns of debt funds are not fixed as they depend on the performance of the underlying debt securities under the scheme. Hence, these returns are subject to market volatility.
2. Diversification
Debt Funds invest in a variety of debt instruments like corporate bonds, government securities (G-Secs) and state development loans (SDL) bonds, reducing risk through diversification.
3. Higher Liquidity
Debt funds have greater liquidity than fixed deposits. This means you can withdraw or redeem your investment at any time without major penalties.
4. Moderate Risk
They are less risky than equity funds. Yet, debt funds are still subject to market fluctuations in uncertain events and interest rate changes by the government.
5. Taxation
The profits that you earn from debt funds are taxed as per your income tax slab rate. However, you only pay taxes when you redeem your units. Unlike FDs, you are not paying any TDS on such returns.
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What is a Fixed Deposit?
A Fixed Deposit (FD) is a financial product that commercial banks offer. These banks are where you deposit money for a fixed period of time at the interest rate as decided by the bank. FDs are known for their guaranteed returns and are ideal for those looking for a risk-free investment.
Features of Fixed Deposits (FDs):
Here are the important things to know about fixed deposits and their key features:
1. Fixed Returns
These deposits offer a guaranteed rate of return at regular intervals. This mechanism makes sure you know the exact return at the end of the maturity of the fixed deposit.
2. Low Risk
They are one of the safest investment options with no exposure to market volatility. Since returns on such deposits do not fluctuate with extreme market conditions.
3. Lock-in Period
All FDs come with a fixed lock-in period, and if you plan to withdraw funds from your fixed deposit, you have to pay penalties. Thus, in this aspect, FDs have a limitation to investing.
4. Guaranteed Principal
In this type of investment, your principal amount is secure. Plus, its returns are unaffected by market fluctuations.
5. Taxation
Interest earned from fixed deposits in India is fully taxable. The tax deducted at source (TDS) applies if the interest earned on FDs exceeds ₹40,000 for individuals and ₹50,000 for senior citizens (persons above the age of 60 and above). The TDS rate is 10% if your returns exceed the threshold amount.
Why Choose Fixed Deposits (FDs)?
Now that you know all about both debt funds and fixed deposits, let us understand why someone would choose fixed deposits over debt funds:
1. Safety
If you are a risk-averse investor, FDs are the safer option. They offer guaranteed returns, making them ideal for conservative investors.
2. Fixed Returns
The returns in FDs are fixed, hence so called. So you know exactly how much you will get at the end of the tenure, providing a sense of security.
3. No Market Risk
Both the investment part and the interest part in FDs are unaffected by market volatility. Thus, investing in such depoits guarantees you timely periodic returns.
Why Choose Debt Funds?
Now let us find out why would someone choose debt funds over the fixed deposits. The probable reasons are as follows:
1. Higher Returns
Debt Funds usually offer higher returns as compared to FDs, especially in low-interest rate environments.
2. Liquidity
You can easily exit a Debt Fund without penalties unlike a fixed deposit. Usually in fixed deposits, making an exit often comes with penalties and extra charges. This makes them more flexible than FDs.
3. Tax Efficiency
While the tax benefits of indexation are no longer available, Debt Funds can still be a better option for those in lower tax brackets.
Wrapping Up
Both Debt Funds and Fixed Deposits have their own specific benefits. If you are looking for guaranteed returns with zero risk, FDs are an ideal choice. However, if you are comfortable with a little market risk and want the potential for higher returns and better liquidity, Debt Funds may be a better fit.
FAQs
Which offers better returns, Debt Funds or FDs?
Debt Funds typically offer higher returns compared to FDs. However, the returns on Debt Funds can fluctuate over interest rate risk, while FD returns are fixed.
Are Debt Funds riskier than FDs?
Yes, Debt Funds are subject to market risks, but they are generally considered lower risk compared to other mutual funds like equity funds. FDs carry almost no risk since they offer guaranteed returns.
Which is more liquid, Debt Funds or FDs?
Debt Funds are more liquid as you can redeem your units anytime without penalties. FDs have a lock-in period and withdrawal before maturity leads to penalties.
Is FD safer than Debt Funds?
Yes, FDs are safer as they provide guaranteed returns and are not exposed to market volatility.
Can I withdraw my FD before its maturity?
Yes, but withdrawing FDs before maturity comes with a penalty and you can lose out on some interest.
Can I redeem my Debt Fund anytime?
Yes, Debt Funds offer higher liquidity as compared to bank deposits, thus allowing you to redeem your units anytime without penalty.
Do Debt Funds offer guaranteed returns like FDs?
No, Debt Funds do not offer guaranteed returns. Their performance depends on the market, though they are typically less volatile than equity funds.
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DISCLAIMER: Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investments in securities market are subject to market risks. Read all the related documents carefully before investing. The securities quoted are for illustration only and are not recommendatory.