mutual funds

Choosing Between Debt Mutual Funds and Fixed Deposits: Which Option is Right for You?

In the year 2023, debt mutual funds witnessed an outflow of ? 46,089 crore, indicating their popularity among Indian investors belonging to different income groups. In light of the changes that the Finance Bill 2023 has affected in relation to debt mutual funds, investors are now considering fixed deposit (FD) investments as alternatives to the former. Which one should you pick? Find out by understanding the key differences between debt funds and fixed deposit accounts. Read until the end to find a summary of the changes that investors can expect after investing in debt mutual funds, after the Finance Bill of 2023 has come into effect.

What is a debt fund, and how does it work?

Debt mutual funds are a category of mutual funds that invest solely in fixed-income securities such as treasury bills, corporate bonds, commercial papers, government securities, and other money-market instruments. Fixed-income securities have a fixed interest rate that helps the investor earn a fixed income at the time of maturity. These returns are deemed “fixed” since they are not affected by market volatility, which is the reason why debt mutual funds are considered to be low-risk investments.

How to choose between investing in an FD and a debt fund investment?

To make an informed decision while choosing between an FD and a debt fund investment, investors must assess the features of both investment options and then choose one:

FDs offer fixed returns whereas debt fund returns are not fixed

Fixed Deposit accounts have a fixed interest rate that is decided by the bank or financial institution offering the FD. This interest rate can change based on the investor’s investment horizon or depending on the bank offering the FD. On the other hand, debt fund returns are not guaranteed, since they are dependent on the performance of the underlying assets that are affected by market volatility.

 FDs and debt funds pose credit risk to the investor

A “credit risk” is the risk associated with the loss that an investor faces when an issuer defaults on a bond or fails to make a payment on time. In this scenario, owing to the borrower’s inability to repay their debt in full, the lender faces a financial loss. Investors must note that FDs issued by nationalised banks generally have the least credit risk. Investors should check a debt fund’s investment objectives to understand its risk level.

FDs are flexible investments, whereas debt funds offer diversification

Fixed deposit accounts offer higher flexibility to investors, whereas debt mutual funds help them diversify their investment portfolios. Investors who wish to prioritise diversification can choose debt funds over FDs.

Debt mutual funds charge an expense ratio from the investor

A key difference between the two investment options are the charges involved. FD investments have a zero-investment cost, whereas debt mutual funds charge an Expense Ratio from the investor in lieu of fund management services.

The taxation rules for debt mutual funds have now been amended

According to the Finance Bill 2023, the concept of “long-term capital gains” has been scrapped in regard to the taxation of debt mutual funds. Therefore, investors who remain invested in a debt mutual fund for more than three years will no longer receive any indexation benefits.

To better gauge whether a particular FD will help them meet their financial goals, investors can refer to an online FD returns calculator to plan their investment in advance. It is important for investors to consider the changes in taxation brought about by the Finance Bill 2023 before investing in debt mutual funds.

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