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Are FDs better than debt funds in present times?

  • Debt funds provide better returns and a tax incentive
  • The choice depends on risk appetite of an investor

Debt funds are seen as superior to fixed deposits because not only are they capable of generating higher returns but are also more tax efficient. Gains on debt funds that are held for less than three years are deemed to be short-term capital gains and are taxed as per the marginal tax rate applicable to the individual, just like fixed deposits. However, in the case of long-term capital gains—when the fund is held for more than three years—the gains are taxed at 20% after indexation, a benefit not available for fixed deposits. For individuals with higher income, therefore, debt funds are seen as a superior choice even though they are market-linked products and their returns are likely to be variable and not fixed. One of the other main risks of investing in debt funds is credit risk, and the recent credit events such as the II&FS default, probable risk of a credit downgrade at the Essel group have exposed the vulnerability of debt funds. In the light of this, Mint asked four experts how debt funds stack up against fixed deposits for retail investors.

If holding period is less than 6 months, pick fixed deposits

Kalpesh Ashar, Full Circle Financial Planners and Advisors
Kalpesh Ashar, Full Circle Financial Planners and Advisors

Kalpesh Ashar, founder, Full Circle Financial Planners and Advisors

Credit downgrade and defaults have happened in the past but the events have been few and far between. However, this time around, three main events—II&FS default, probable risk of a credit downgrade at the Essel group and trouble at DHFL—happened in a short span of time and this is worrisome.

What is also worrying is that for the first time, even ultra-short term funds and other low duration funds have exposure to these companies. These funds are recommended to hold one’s emergency corpus or to realise very short-term goals as the volatility risk is minimal. But if these funds become vulnerable to a credit default or a downgrade, then investors could be caught on the wrong foot.

Given recent events, I am compelled to say that if your holding period is less than six months, then opting for fixed deposits is advisable instead of ultra-short term and low duration funds. If your investment horizon is more than six months, you could consider these funds, as a longer-term horizon will help recoup any losses.

Debt funds provide better returns and a tax incentive

Gajendra Kothari, Etica Wealth Management Pvt. Ltd
Gajendra Kothari, Etica Wealth Management Pvt. Ltd

Gajendra Kothari, Managing director and chief executive officer, Etica Wealth Management Pvt. Ltd

Fixed deposits and debt funds are completely two separate products both from risk/return perspective. FDs (particularly from scheduled commercial banks) virtually carry very low credit risk, while debt funds by nature offer a managed risk portfolio. Even in mutual funds, there are different debt funds to choose from based on an investor’s risk appetite (from overnight funds to credit risk funds).

The biggest advantage a debt fund offers is in the form of long-term capital gains taxation which makes a lot of difference to an HNI (high net-worth) investor from the point of view of post-tax returns.

If an investor is looking for a completely safe product with absolutely no volatility, then she should clearly go for an FD.

However, a debt fund certainly offers better risk-adjusted returns over the longer term. One should remember that accidents like these will happen once in a while but that doesn’t mean one should shun debt funds completely. Debt funds should definitely have a prominent place in a client’s portfolio.

The choice depends on risk appetite of an investor

Dilshad Billimoria, Director, Dilzer Consultants Pvt. Ltd

Risk has to be understood primarily at two levels. One, at the fund manager level in picking securities to buy, and two, at the investor level where the advisor recommends options to the investors depending on their risk appetite. The advisor, in turn, depends on the expertise of asset management companies on security selection. Risk measurement, management, monitoring and finally mitigation play an important role in managing debt portfolios by asset management companies.

The decision on investing in a debt fund or a fixed deposit will depend on the risk appetite of investors. Debt funds offer better post-tax returns to the investor if held for more than three years, with good liquidity options. There are also tax-free government bond options offered at attractive pre-tax rates of 9-9.50% at zero credit risk. This option is suitable for investors in the highest tax bracket.

Liquid and ultra-short term funds invest in overnight call money that do not have the credit risks, and they also provide better returns compared to fixed deposits.

Don’t panic, invest in risk monitoring system instead

George Mitra, Avendus Wealth Management
George Mitra, Avendus Wealth Management

George Mitra, Managing director and chief executive officer, Avendus Wealth Management

When we choose fixed-income funds over fixed deposits, do we acknowledge the associated risks, including the potential loss of principal, even in so-called “safe" debt investments?

If we do, why are we surprised when things start blowing up in debt markets? Is it because we expect our fund managers to foresee things and ensure our risk is contained? Fund managers, in their chase for yields, often have to take on additional risk. You see the conflict here?

As investors, we need to remember that there is always some risk involved when making any investment, which keeps changing, and not doing anything about this may only make it worse.

Instead of moving from one investment product to another in order to ensure safety, you should invest in a robust risk monitoring system to stay ahead of the curve. So, find a good and trustworthy advisor, whose job is to act as a watchdog on your behalf. Timely advice based on early warning signs can save you from much heartburn.




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