Why Fixed Deposits Are Not The Best Investment Avenues

Summary Recommendations

Debt Funds deliver better post tax returns in comparison with Fixed Deposits especially for the investors in higher income tax bracket.
Debt Funds provide more liquidity to investors with no lock in period for the amount invested.

Limitations of fixed deposits

TAXATION: Debt funds deliver tax efficient returns when compared with fixed deposits

	Fixed Deposits	Debt Funds
Amount Invested	Taxable	Taxable
Interest Earned	Taxable as per income tax slabs Up to 33.33%	Short Term Capital Gain Tax: Taxable as per income tax slabs - Up to 33.33% Long Term Capital Gain Tax: Less of 10% without indexation or 20% with indexation
Dividends received	NA	Tax free in the hands of investor Dividend distribution tax of 14.16% is paid by the Asset Management Company

*Taxation rates indicated above are inclusive of surcharge (10%) and education cess (3%)

Taxation in case of debt funds is more investor friendly when compared with fixed deposits especially for the investors in higher tax bracket
In the short term investment horizon, investor gets the benefit of lower dividend distribution tax in debt funds
In the long term investment horizon, investor gets the benefit of indexation in debt funds

LIQUIDITY: Debt Funds are more liquid than Fixed Deposits

Fixed Deposits

Debt Funds

The amount invested gets locked in for the tenure of the fixed deposit (14 days, 3 months, 1 year, 5 years etc.)

The amount invested is highly liquid and can be redeemed in T+1 days

Debt Funds are highly liquid as the amount invested can be redeemed in T+1 days unlike fixed deposits where money gets locked in for a fixed period of time.

Operational efficiencies: No TDS deduction in case of Debt Funds

Tax Deducted at Source : If an investor earns interest of more than Rs 10,000, TDS is deducted on this interest income and investor is required to collect this TDS certificate from the bank. No such TDS is deducted in case of debt Funds

RETURNS: Better Post Tax returns in case of debt funds

Though the pre tax returns are in the same range of 8-9%, but variation can be seen in post tax returns. Let us discuss two scenarios:

	Investing Period < 1 year		Investing Period > 1 year
	Fixed Deposits	Debt Funds (Dividend Option)	Fixed Deposits	Debt Funds (Dividend Option)
Amount Invested	Rs 1,00,000	Rs 1,00,000	Rs 1,00,000	Rs 1,00,000
Assumed rate of return	9.50%	9.50%	9.50%	9.50%
Term of Investment	3 Months	3 Months	14 Months	14 Months
Dividend Received	NA	2,295	NA	11,169
Interest Earned	Rs 2,295	NA	Rs 11,169	NA
Tax Rate Applicable	33.99%	14.16%	33.99%	14.16%
Tax Paid (B)	Rs 780	Rs 285	Rs 3,796	Rs 1,386
Post Tax return (A-B)	Rs 1,515	Rs 2,010	Rs 7,373	Rs 9,783
Annualized Post tax return	6.20%	8.29%	6.29%	8.33%

Debt Funds deliver better post tax returns when compared with fixed deposits
In the short term and long term investment horizon, investor earns better post tax returns by investing in debt funds.

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Comments


Investor said : 11/08/2010	Savings Accounts and FDs - First of all, a savings account earns you 3.5% interest rate,(calculated daily). This itself is not bad considering the all-time access to money and peace of mind. Similarly, a fixed deposit gives you 7-8 % per annum (compunded quarterly), and you cannot earn less than what you signed up for. There are no fees, commissions. There is no fear of losing capital if you only invest in nationalised banks and in each branch your deposit is not more than 1 lakh. Even if stock market collpases, you have no reason to worry. Compare this to a return that the equity market can earn you. History and experience of equity markets from around the world suggests that only in the long-term (around 10 years)equity markets are likely to "compound your capital" at approximately 10% per annum. This is not guaranteed. Many individuals' wealth was completely wiped off in the stock market. Compared to this, a 8% FD rate is more secure. FD can be made for just 1 year. Also, you do not lose your sleep. If you do not want to live in poverty and then die rich. avoid stock market. Invest bulk in FD, some amount in gold, silver, and if you have large amounts of money by land, shop, or a house. Do not go anywhere near stock market.
ganesh said : 17/05/2010	Seems the author has conveniently ignored any management cost involved with the fund. With Fixed Deposits, there is no management overhead
WILSON said : 16/10/2009	Dear Sir Your article shows only about advanatge over tax. What about the downward risk of the investment value if there is flucation in the market. How will i calcluate the difference between what is save in tax and lose if there is a fluctuation in market. Is there any barometer to calculate the same. Please advice Regards Wilson

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