BackDebt funds may score over Post Office Schemes
Comparison of investments are, typically, based on three parameters, referred to as SLR—safety, liquidity and returns
PremiumBefore we discuss which one is better—debt mutual funds or post office (PO) schemes—let’s first look at the fundamental difference between the two. Bank deposits, corporate deposits and PO schemes, among others come under the category of fixed-income instruments, popularly known as guaranteed return schemes, and which may also be referred to as contractual or committed return investments.
While bonds or fixed-income instruments have a defined maturity and committed interest, there is a difference in the way a debt mutual fund functions. A mutual fund scheme is a market-oriented investment as investors enter and exit the pool every day. Market valuation is done every day. The net asset value (NAV) is the market-based valuation for entry and exit that day. Hence, returns from a mutual fund are not only about the maturity of, or interest in, bonds in the portfolio but also about the market movement. Here market movement means movement of interest rates in the secondary market for bonds, which is dependent on many volatile factors. To put the same thing in other words, your return in a bond mutual fund is defined not only by purchase-of-bond-to-maturity-of-bond but also by market-level-at-entry-to-market-level-at-exit. However, over a long investment horizon, market cycles tend to even out.
Comparison of investments are, typically, based on three parameters, referred to as SLR—safety, liquidity and returns.
Safety: PO schemes are completely safe as they are run by the government. Debt mutual funds are also safe. Though certain defaults happened in 2018 and 2019, wherein some bond issuers, including IL&FS and DHFL, did not honour their commitment, you may stick to good credit-quality debt mutual funds to minimize the chances of default, if any. Recently, there was a lot of noise about Franklin Templeton Mutual Fund shutting down six of its debt schemes. Though the winding up was hard on the investors, it should be noted that it was not a scam. Nobody has run away with the money; investors’ money is there in the fund and it will come back. The timing of refund is being decided by the Karnataka high court.
In terms of safety, bank deposits are safe, but you have to choose your bank. There are public sector banks that have the implied safety of government ownership (which is different from the ₹5 lakh deposit insurance per customer), there are leading private sector banks and there are other banks. You are aware of the incidents of a private sector bank, which was rescued in the form of ownership taken by multiple leading banks, and certain co-operative banks that have failed.
Liquidity: Mutual funds are more liquid than PO schemes. In certain PO schemes, there is a defined lock-in period. For example, Kisan Vikas Patra (KVP) can be encashed after two-and-half years but can be transferred to another person earlier; National Savings Certificate (NSC) can be transferred to another person only once, in Sukanya Samriddhi Yojana (SSY), partial withdrawal is allowed after the girl reaches 18 years of age, while PO Monthly Income Scheme (POMIS) can be encashed after one year but at a discount. In a few MF schemes, there is an exit load, but if you think you may require the money at short notice, you may choose schemes that do not have exit load. MF purchase and redemption is executed online, which effectively adds to liquidity. Bank deposits can be transacted digitally, but there may be a small pre-mature withdrawal penalty.
Returns: It is not correct to compare the returns of the two as one is contractual and the other is market-driven, but returns from PO scheme are currently attractive. For example, NSC carries 6.8% plus Section 80C benefits; KVP carries 6.9%. It is unlikely that good-portfolio-credit-quality MF schemes will match these returns. However, in MFs, there is a tax advantage over a horizon of three years of holding. In the growth option of debt MFs, over three years, with the benefit of indexation, the effective tax rate of 20% comes down significantly. In PO schemes, the interest is taxable at your marginal slab rate. So for those in the 30% tax bracket, returns from MFs and PO schemes become comparable.
Another aspect is the upper ceiling. For example POMIS has a limit of ₹4.5 lakh. Considering the aspects of SLR, you can take your pick between the two, or you can allocate a part of your fixed income which may not be required immediately to PO schemes. For liquidity and long-term wealth creation (given the tax advantage for investments held for three years), MFs are useful.
Joydeep Sen is an author and corporate trainer (debt markets)
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