So, a young investor may face a dilemma of choosing to invest between fixed deposits and debt mutual funds. Worry not. This post compares both investment options on various parameters to help you make a more informed decision.
In the case of debt funds, taxation works differently. Income from your debt fund investment is taxable as “Income from Capital Gains”. Hence, the income becomes taxable only when you sell the units and not every year. If you sell units within 3 years, it gets taxed as per your tax slab (similar to FD). But if you sell after 3 years, income qualifies as “long term capital gain” & taxable at a reduced rate of 20%, along with the benefit of indexation.
So, a great tax planning strategy is deferred taxation – this involves holding on to the investment for long periods. By doing that, you postpone taxation & reduce your tax liability. This tax planning advantage is not available in fixed deposits.
One more thing. Debt funds are not available for a tax deduction. However, within fixed deposits, there is a particular category of tax saver fixed deposits with a lock-in of 5 years. Interest from those FDs is taxable.
However, in debt funds, the fund is invested in multiple commercial papers. Hence, there is no fixed return promise. Mostly, it is in line with the return that the scheme earns from those papers, less the fund management fee.
However, the difference comes in the post-tax return. For investors in higher tax brackets, the post-tax return from debt funds is superior to fixed deposits.
For example, if you earn an 8% return and fall in the 30% tax bracket, your post-tax return will be a mere 5.6% in the case of a fixed deposit. Whereas in the case of debt funds, you can do some intelligent planning & stay invested for more than 3 years. In that case, factoring in the indexation, the tax impact will be significantly less & the post-tax return will be much higher than FD.
However, as an FD investor, don’t just rely on insurance. In case of default, the procedural delay can cause a lot of delay in receiving the funds. Prefer scheduled banks to co-operative banks while choosing the bank. In case of significant FD investment, split it across banks as the insurance of ₹5 lacs applies on a per bank basis.
Early withdrawal penalties:
Debt mutual funds are highly flexible in this regard. There are nil charges or a minimal charge (known as exit load) that apply if you withdraw early.
- Systematic Investment Plan (SIP): Helps you to systematically invest per month, building
- Systematic Transfer Plan (STP): Helps you to systematically transfer your money into other schemes of the same fund house.
- Systematic Withdrawal Plan (SWP): Helps you withdraw a fixed amount from your corpus every month. Ideal for people who want to create a regular stream of income.
In fixed deposits, these features are not available, and you will have to manually move funds which require time & effort.
Our verdict: What should a young investor prefer?