SEO Simplified By Gabs Gaurs & Geets: Prajna Capital

Sunday, July 26, 2015

Prajna Capital

Posted: 26 Jul 2015 12:57 AM PDT

For a beginner, fixed deposits seem a natural choice but debt funds have many advantages over them

Most investors assume debt funds to be a direct alternative and competitor against bank fixed deposits. This is a fair comparison, as the two serve the same purpose in anyone's investment portfolio. However, there are some differences that the investors should understand. The foremost difference is in terms of safety and taxation (and thus returns). Mutual funds have an advantage with tax-adjusted returns and while fixed deposits with safety.

Like all mutual funds, there are no guarantees in debt funds. Returns are market-linked and the investor is fully exposed to defaults or any other credit problems with bond issuing entities. However, that's a legalistic interpretation of safety of your investments in funds.

In practice, the fund industry is closely regulated and monitored by the regulator, Securities and Exchange Board of India (Sebi). Regulations put in place by Sebi keep tight reins on risk profile of investments, concentration of risk that individual funds face and valuation of investments. Sebi also tracks how closely the maturity profile hews to the fund's declared goals.

In past, these measures have proved to be highly effective and except for some small problems during the 2008 global financial crisis, debt fund investors have not had any nasty surprises. Practically speaking, you would be entirely justified in expecting not to face any defaults in your debt fund investments.

In theory, banks are safer but in our view, there is no practical difference between the safety level of banks and debt funds as far as defaults of underlying investments go. However, that's not a guarantee.

The other big difference is that of taxation. Returns from bank fixed deposits are interest income and have to be added to your normal income. Since many investors are in the top (30 per cent) tax bracket, this effectively reduces return by an equal percentage. The returns from debt funds are classified as capital gains and are thus taxed at 10 or 20 per cent. If you take into account indexation benefits, then the difference between Fixed Deposit returns and debt fund returns are quite large. And if you can time the investment to get double indexation benefits for say a 370-day deposit, then its quite a bonanza. All in all, debt funds are a superior alternative to fixed deposits.