Debt funds have smaller returns than equities funds, but these mutual fund classes are less susceptible to market volatility. So choose debt funds if you want to ensure the security of your principle and a reliable return. Debt funds provide a better return than traditional savings accounts and fixed-term deposits.
Debt mutual funds also allow investors to invest in much safer credit products, such as corporate and government bonds. Even fixed cash flows through interest payments are offered to investors by a few debt mutual funds, sometimes known as fixed-income mutual funds.
Every investor worries about the danger of investing due to the shifting market and economy. FDs have consistently been the most widely used investment strategy. However, there has been a new trend where people have also actively begun to participate in debt mutual funds.
Debt mutual funds and fixed-income securities differ significantly from one another. An FD guarantees you receive your entire principal sum plus interest at maturity, even though a mutual debt fund may offer higher returns.
Treatment of interest earned on FDs and dividends on debt funds
FDs also have a tax disadvantage in addition to providing lower interest rates. Bank FD interest is regarded as regular income by the investor and is consequently subject to taxation at your top rate of taxation. The post-tax yield on your bank FD will be only 5.6% after accounting for taxes if you are in the 30% tax band and it offers you 8% interest. That scarcely covers the risk of long-term historical inflation in India. However, the investor is entirely tax-free concerning the dividends received from debt funds.
Treatment of capital gains
This is yet another aspect of bank FDs and debt funds that investors should be aware of. Naturally, there is no concern about capital gains when it comes to bank FDs because they are always redeemed for their face value.
However, there is a capital gains issue with debt funds. To calculate capital gains, debt funds are considered non-equity financial assets. As a result, in the case of debt funds, the threshold for classification as long-term capital gains is three years. Debt funds sold within three years of purchase are considered short-term capital gains and subject to your highest tax rate.
However, the vast majority of debt funds choose to distribute their gains as dividends since they are more tax-efficient. That explains why, when it comes to debt funds, the majority of investors favour dividend plans. One thing must be said here in favour of bank FDs.
An extra benefit of exemption up to Rs. 150,000 will be available on just this investment on Section 80C of the Income Tax Act if an investor places money in a long-term (5-year) term FD with a bank. In contrast to long-term bank FDs, equity ELSS plans offer a more profitable option to save tax if Section 80C is your goal.
However, due to the fact that dividends are more tax-efficient, the large bulk of debt funds opt to distribute their gains in this manner. That is why the vast majority of investors chose dividend programmes regarding debt funds. Here, one argument in favour of bank FDs must be made.
If an investor invests funds in a long-term (5-year) term FD with a bank, an additional advantage of exemption up to Rs. 150,000 will be provided on this investment under Section 80C of the Income Tax Act. If Section 80C tax savings is your goal, equity ELSS plans offer a much more profitable alternative to long-term bank FDs.
You must recognize debt funds if you want a relatively higher return than you would get from bank savings accounts and fixed deposits while still receiving tax advantages.