Bank fixed deposits are one of the oldest tax saving instruments in India. People have been investing in bank FDs for many years now. They have been benefiting from the interest offered by bank FDs. However, these days more and more people are shifting to debt mutual funds instead of bank FDs especially because of the slump in the interest rates on offer.
Why Indians preferred bank FDs?
Back in the day, bank fixed deposits had so much importance that even little idle money, money receive through increment / bonus was invested in it. Bank FDs were probably the best and safest option for our parents and grandparents to put back in the day. There wasn’t a better investment scheme that offered capital protection and stable interest.
Ever since mutual funds have been introduced, bank FDs have lost their charm. They are no longer the preferred long term investment option. Introduction of tax saving scheme like ELSS has made mutual fund an investor’s favorite investment mode. Another reason why more and more conservative investor joined the band wagon is because debt funds started offering very high liquidity with decent returns.
Debt funds v/s bank fixed deposits
|Particulars||Debt funds||Bank FDs|
|Average rate of return||8% to 9%||4% to 5%|
|Dividends offered||Debt funds offer dividends||Fixed deposits do not offer any dividend|
|Risk||Debt funds carry low to moderate risk||Bank FDs have very low risk unless the bank shuts down without any prior notice|
|Liquidity||Debt funds offer immense liquidity that allows investors to buy or sell units according to their will||There is no liquidity as bank FDs come with a lock-in period|
|Investment method||Investors can either make a onetime lumpsum investment or they can opt for a Systematic Investment Plan through which they can invest small amounts at regular intervals||One can only make a lumpsum investment in bank FDs|
|Early redemption||Investors can withdraw investments in debt funds as per their will. Exit load may or may not be levied||Upon prematurely redeeming the invested sum, investors may have to pay a penalty to the bank|
|Costs involved||Investors have to bear the expense ratio levied on the fund||No management costs involved as the money is locked in for a predetermined period|
Which investment avenue offers better post tax returns?
Although both debt funds and bank FDs are treated as debt instruments, the taxation on both is different. All the returns earned through FDs have to be in the annual income tax return file. This is not the case with debt mutual funds because they are taxed only when the investor decides to redeem the gains.
For a holding period of three years or less, the taxation rules for returns earned from both bank FDs and debt funds are the same. Investors are taxed depending on the tax slab they fall under.
But if you take a holding period of three years or above, the tax filing rules apply same for returns earned from bank FDs. However, these aren’t the same when it comes to debt funds. That is because the returns accumulated over the period of three years are treated as capital gains. And the tax rules for capital gains are different. Capital gains earned after three years are treated as long term capital gains and the investor will be charged a tax of 20% after indexation benefit. Indexation benefit is what makes returns from debt funds more efficient than returns earned from bank FDs.
This is why post tax returns earned from debt funds will always be better than those earned from bank FDs.