Earlier, debt fund investors were eligible to claim indexation benefits on long-term capital gains for investments held for over 3 years. This was eliminated by the Finance Bill of 2023. Since debt funds are now taxed as per your tax slab, many conservative investors wonder if it makes sense to choose debt funds over FDs. This article outlines why debt funds are better than FDs, even under the revised taxation provisions.

• Debt funds offer higher inflation-beating returns than FDs.
• Investing in debt funds ensures easy liquidity and flexibility benefits.
• No TDS is applicable on the capital gains accruing from debt funds.

Fixed deposits are a type of term deposit account where you invest a lump-sum amount of money for a predetermined tenure and earn interest at a fixed rate. The interest is paid out periodically (non-cumulative FD) or at the end of the maturity tenure (cumulative FD). Since returns are guaranteed and fixed, FDs are considered to be low-risk investment instruments ideal for risk-averse investors. If you are looking for a safe investment option, you can consider fixed deposit. They offer guaranteed returns and a fixed interest rate throughout your investment tenure.

Debt funds are a type of mutual fund that pools money from different investors to invest in fixed-income securities like bonds, commercial papers, debentures, CDs, and treasury bills. Debt funds offer a potential for higher returns than FDs, but also carry a higher risk quotient. In other words, returns on your debt fund investments can fluctuate depending on the market.

If you’re a low-to-moderate risk investor, you may be conflicted about choosing between debt funds and FDs. Let’s see why debt funds are better than FD investments:

Higher interest earnings

Better returns is one of the greatest advantages of choosing debt funds over FDs. FD interest rates generally range from 6%-8% p.a., depending on the tenure of the FD. Senior citizens generally enjoy a higher interest rate than regular investors. However, debt funds offer a better return rate of around 7%-9%. In other words, you have the opportunity to earn higher returns with debt fund investments.

Relative safety

Debt funds are market-linked products susceptible to market fluctuations and certain investment risks. Despite this, debt funds can be relatively safe investments if selected carefully. Picking funds that invest in AAA-rated securities can minimise the credit risk associated with debt funds. Highly rated securities ensure ultra-low default risk, making debt funds ideal for investors looking at reliable and high earnings.

Easy liquidity

Another crucial advantage of picking debt funds over FDs is the liquidity boon. In the case of a bank FD, premature withdrawals are permitted after penalty interest rate cuts. For debt funds, you can withdraw the invested amount - wholly or partially - without any penalties. However, you may have to pay a nominal exit load if you withdraw before the minimum lock-in window (usually 1 year). Certain types of debt funds, like overnight and liquid funds, do not carry such exit loads, making premature withdrawals completely free.

Inflation-adjusted returns

If you’re wondering why debt funds are better than FDs, a simple reason would be inflation-adjusted returns. Debt mutual funds have the potential to offer returns that outpace inflation, preserving the real value of your invested funds. Alternatively, FDs have a fixed interest rate, which remains constant throughout the investment tenure and can easily fall short of the inflation rate, effectively lowering the purchasing power of your funds.

No TDS deductions

One of the chief advantages of choosing debt funds over FDs is the absence of TDS payments. Interest earned on FD investments attracts a 10% TDS if they exceed Rs. 40,000 in a given fiscal year (Rs. 50,000 for seniors). However, no TDS is applicable on gains you make from debt fund investments.

Investment flexibility

Investment flexibility is yet another reason why debt funds are better than FDs. Fixed deposit investments require a lump sum deposit that’s locked in for a specific period of time. For debt funds, you can invest through the lump sum route or opt for SIP investments, where you contribute a fixed sum at regular intervals. In fact, debt fund SIPs also help you lower the average investment cost through the power of rupee-cost averaging. You can consider investing Bajaj Finance Fixed Deposit. With a top-tier AAA rating from financial agencies like CRISIL and ICRA, they offer one of the highest returns, up to 8.60% p.a.

In a nutshell, debt funds offer several advantages over FD investments. While both are conservative investment avenues, debt funds offer better return potentials and the possibility of inflation-beating earnings. However, debt funds are also susceptible to credit and interest rate risks, while FDs are 100% secure investment options. So, if you prioritise capital safety, opt for FDs, while if you want higher returns and are comfortable with a slightly higher risk exposure, choose debt funds.