Bank FDs outscore debt funds in terms of capital protection and income certainty. The booked interest rates of bank FDs remain the same throughout the FD tenure, despite changes in the FD rates in the interim. FDs opened with scheduled banks also qualify for the depositor insurance program of DICGC, an RBI subsidiary. This program covers cumulative bank deposits (including savings, fixed, current and recurring deposits) of up to Rs 5 lakh of each depositor with each scheduled bank in case of bank failure. Hence, those having deposits with multiple scheduled banks will qualify for the depositor insurance cover with each of the banks.
Despite having lower risk than equity funds, debt mutual funds cannot guarantee capital protection as their portfolio constituent securities are susceptible to interest rate risk and credit risks. Debt funds also cannot provide income certainty as their returns are a sum of capital appreciation/erosion and coupon income generated by their portfolio constituents.
Bank FDs also outscore debt funds in terms of investment cost. Bank FDs do not charge any fee for opening and maintaining fixed deposits. The operating, administrative and other expenses incurred by debt funds are expressed in the form of expense ratio and are recovered from the investors by deducting them from the funds AUM.
Most of the bank fixed deposits, barring tax saving FDs, allow premature withdrawals. However, most banks usually charge a penalty of up to 1% on premature withdrawals. In case of debt funds, except for the fixed maturity plan, investors are free to redeem their debt funds any time after investment. However, some debt funds may levy exit load on redemption before pre-set timelines.
Debt funds usually beat bank FDs in terms of returns. Debt funds primarily invest in fixed income securities traded in the bond and money markets, which usually offer higher risk premium than bank FDs.
Debt funds also outscore bank FDs in terms of tax treatment, especially for those falling in the higher tax slab and those with investment horizons exceeding 3 years. The capital gains from debt funds booked within 3 years are taxed as per the tax slab of the investor whereas the capital gains booked after 3 years are taxed @ 20% after indexation. The interest income generated by bank FDs are taxed as per the depositors income tax slab.
Bank FDs beat debt funds in terms of capital protection, income certainty and investment cost whereas debt funds beat bank FDs in terms of returns, tax treatment and liquidity.
(Expert comments by Sahil Arora – Director, Paisabazaar.com)