Fixed Deposits (FD) are not just an investment vehicle, they are a part of our Indian tradition. As soon as you start earning, you would have heard your elder family members saying that a good portion of your portfolio should be invested in FDs for Safety and Liquidity. A sign that the individual is capable of managing his finances and can save for long-term goals. While they are right about investing a portion of your portfolio into the so called ‘Riskless Liquid Investments’- FDs might not be your best bet today.
During the 90s, the FD rates were around 13%. Hence FDs were lucrative. But since then we’ve seen a steady fall, and the current FD rates (of bigger & safer banks like SBI, HDFC, KOTAK, ICICI) have plateaued to approximately 5.25 % (for a duration between 1 year to 10 years).
The declining interest rate regime and the excessive liquidity caused by demonetization & then covid-19 have forced banks to reduce their FD interest rates to historic lows. This, in turn, is forcing many retail investors to turn towards smarter investment alternatives like debt mutual funds.
Investment in debt mutual funds is a much better option than parking your money in bank FDs. Let us look in major reasons for this:
1. Contrary to popular belief, FDs are not Risk-Less.
Under the Deposit Insurance and Credit Guarantee Scheme of India, only fixed deposits up to 1 lakh (Proposed by FM to be increased to 5 Lakh) are insured. So, in case of an unforeseen circumstance, you will only receive this amount back, and not your complete invested amount with interest. So, while banks have made it easy to open online fixed deposits and have multiple fixed deposit accounts, little has been down to safeguard your investment. And you’ve seen what went happened with PMC Bank, Yes Bank, Sri Gururaghavendra Sahakara Bank, Niyamitha Bank. All things pointing in one direction -> FDs are not Risk-Less.
2. FD renewals and pre-mature withdrawals are both detrimental. No Liquidity.
One of the primary reasons why we keep some of our money in FDs is that they can be broken/money can be withdrawn whenever required. However, most banks have pre-closure charges for breaking a fixed deposit before it matures and don’t offer the same interest rate if the deposit is not held for the full term. This means that your investment has actually lost money. The same holds true for renewals as well. It’s customary for individuals to renew fixed deposits without analysing the profits made during the initial tenure. Moreover, with the reducing FD rates, it’s likely that you’re reinvesting your money for lower returns than before.
3. Taxation: Fixed deposits and debt funds are taxed differently. Interest income from fixed deposits are added to your taxable income and you have to pay income tax according to that income. In the case of debt funds, you have to pay capital gains tax. If you redeem debt funds before three years of investment, it will get the same treatment as a fixed deposit – that is, gains will be added to your income, and you will have to pay income tax according to your slab rate. If held for over three years, the tax on debt funds is 20 per cent with indexation, and 10 per cent without indexation. Indexation adjusts the purchase value of your investment for inflation, reducing the capital gain, and hence your tax burden
4. Tax Deducted at Source (TDS)
Apart from above mention taxation, banks also deduct TDS on interest income from fixed deposits since as per the Income Tax Act, any company or person making a payment is required to deduct tax at source if the payment exceeds certain threshold limits. TDS has to be deducted at the rates prescribed by the tax department.
However, as a resident Indian, there will be no TDS when you sell/redeem your debt fund units. This vastly removes the burden of matching your Tax Credits with the Bank every year since we generally find a lot of errors by bank officials.
5. In the long run Inflation rates beat Interest rates.
Inflation rates in India are at an average of 5%, and the current rate of interest on fixed deposits post-tax (assuming taxation rate of 30%) is less than 3.5% and hence earnings from fixed deposits after deducting tax cannot beat inflation in the long-run. Further, major expenses of the future like health, education, real-estate investments, will only be higher than present-day rates. So, Investors need to carefully assess these factors and invest in appropriate asset classes to be able to beat inflation.
Thus, Richfield Fintech strongly suggests investing in Debt Mutual Funds from the tax point of view, especially if you hold them over the long term.