So let us now begin with our learning session today.
‘Why should I not invest is FD?’ is the most common question asked by many.
Among some of the best practices followed by top investment managers, tax emerges as an important aspect to be considered. It is common to see advisors in the West talking about pre-tax returns, and more importantly, post-tax returns.
However, in India, we do not talk about post-tax returns when talking about the returns of bank fixed deposits.
Many of you may be quite familiar with this traditional investment instrument that is considered safe and caters to the needs of a large category of investors in India, even today. Being a financial instrument provided by banks in India, it offers returns better than the regular savings account and hence enjoys an edge when it comes to earning better returns on one’s savings. Yes, we are talking about ‘Fixed Deposits’.
But among some of best practices followed by top investment manager, tax emerges as an important aspect to be consider. Its post- tax returns. More importantly however in india we don’t talk about post tax returns when we are taking decision about investment
As investors it is important for us to ask your financial advisors, bankers or agents about the post-tax returns. The impact of tax on investment decisions cannot be underestimated.
It usually ends up in a long debate when it comes to comparing fixed deposits with other investment avenues like mutual funds. In our learning session today, we’ll try to present a clear and unbiased comparison which may help you choose a suitable investment avenue (i.e. Mutual Funds or Fixed Deposits) to meet your financial goals.
So, let us see which of these are more advantageous – mutual funds or fixed deposits. But first, let us take a look at what are…
- Easley available from Traditional financial instrument offered by Banks
- Commonly comparing between saving account interest rate with FD interest rate
- Fix interest rate for specific Tenure
- Fixed Deposits come with a pre-defined Maturity Period (…You can fix your money at a higher rate, right from 7 days to as long as 10 years)
- Fixed Maturity Period and freedom for pre-defined maturity ( with Bank may charge a Penalty for Premature withdrawal )
- Fixed Deposits are consider to be safe Investment – as they are covered by DICGC upto 1,00,000 per depositor per bank
Mutual Funds vs. Fixed Deposits
|Parameters||Mutual Funds||Fixed Deposits|
|Rate of Returns||No Assured Returns||Fixed Returns|
|Inflation Adjusted Returns||Potential for High Inflation-adjusted Returns||Usually Low Inflation-adjusted Returns|
|Risk||Medium to High Risk||Low Risk|
|Liquidity||Liquid||Medium to Low Liquidity|
|Premature Withdrawal||Allowed with Exit Load||Allowed with Penalty|
|Cost of Investment||Management Cost||No Cost|
|Tax Status#||Favourable Tax Status||As Per Tax Slab|
is an important aspect which should be considered while choosing between mutual funds and fixed deposits. You would agree that you will like to make high post-tax returns from your investment. The tax status of mutual funds is based on their category. While you need not pay any long term capital gain tax on your investment in equity mutual funds, the short term gain is taxable @ 15%. On the other hand your gains from long term investment in debt mutual funds (i.e. over a period of 1 year) is taxable @ 20% with indexation and 10% without indexation (whichever is lower); while your short term capital gain from debt and liquid mutual funds is taxable as per your tax slab. As far as fixed deposits are concerned, irrespective of the tenure, the interest which you earn thereon is taxable as per your income tax slab. So, as per the current tax laws mutual funds are quite tax friendly, provided you have held on for more than a year and you are in the highest tax slab.
Fixed deposit – pre-tax vs. post-tax returns
Interest earned on fixed deposit (FD) is taxed at the tax slab rate of the individual. If an individual decides to invest Rs 1,00,000 in an FD at 9 % interest rate, pre-tax interest earned during the year would be Rs. 9000. Tax on the interest earned at 30 per cent tax rate would be Rs 2700, and net amount earned by the investor would be Rs 6300.
This translates into a net return is 6.3 %, which is much lower that the presumed return
The illustration here can help you understand the comparison better…
Mutual Funds vs. Fixed Deposits
|Fixed Deposits||Debt Mutual Fund||Equity Mutual Fund|
|Return (% p.a.)||9.0%||9.0%||9.0%|
|Holding Period||1 Year||1 Year||1 Year|
|Indexed Investment Amount||–||107,500||–|
|Tax Paid (as applicable)||2,700||300||–|
|Post Tax Returns||6,300||8,700||9,000|
|Post Tax Returns (%)||6.3%||8.7%||9.0%|
So above table clearly indicate that FD rate never help to fight inflation, Debt Mutual Fund & Equity Mutual Fund may help to fight with inflation and grow your wealth
‘Why should I not invest is FD?’ is the most common question asked by many. As explained in the above example, a debt mutual fund & Equity Mutual fund could yield more than your FD investment.
Points to Remember…
- Fixed Deposits are traditionally a safe investment instrument that provide Rate of Interest higher than Regular Savings Account
- Fixed Deposits are covered by the Deposit Insurance and Credit Guarantee Corporation an amount of up to Rs 1,00,000 per depositor per bank
- The Rate of Interest on fixed deposits is fixed for a pre-specified Tenure
- Compared to bank fixed deposits, mutual funds have the ability to offer better inflation-adjusted returns
- Fixed deposits are suitable for investors with low risk appetite
- Mutual funds are suitable for investors having relatively higher risk appetite
Ask your advisor if tax has been considered in choosing the recommended products.
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