Comparative Study of Mutual Funds and Bank Deposits
Comparison between mutual funds and fixed deposits is a long debate, especially when it comes to a comparison between fixed deposits and debt mutual funds. Even a few years ago, any conservative and risk averse investor would think investing in bank fixed deposits is better than mutual funds (debt or otherwise). Nevertheless, the market scenario has changed a lot in the recent years, and many a mutual funds family has come up with interest debt mutual fund schemes with guaranteed returns alongside capital appreciations.
This makes the comparison between debt mutual funds versus fixed deposits more complex, and even the most risk averse investor (count my father! ) is led to think twice. That being said, whether you should invest in bank fixed deposits or debt mutual funds is no more a simple question as it used to be five-six years back, and needs a detailed examination and explanation. And, we at Mutual Funds Manager are here again to help you with a neutral comparison between fixed deposits and mutual funds.
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While only you can finally decide whether mutual funds or fixed deposit where to invest — depending on your risk taking abilities, return expectations, and investment horizons — let us try to analyse some key factors one by one and chalk out a comparison between bank FD and mutual funds. 1. Return on investments vary for mutual funds, but not bank deposits Needless to repeat, bank deposits offer you a fixed percentage of return, as would be agreed upon by the investor and the bank at the time of the investment.
For example, if you put 50 thousand rupees in FD for 5 years and the agreed interest rate is 8% per annum, you will continue to enjoy the same interest rate throughout the tenure. On the other hand, debt mutual funds have no assured rate, and the return on investment for debt mutual funds depend completely on the market and the performance of the fund. Fluctuations in the money market impacts the NAV of the fund, thereby altering returns. Thus, a great advantage of bank fixed deposits is that, you will continue to earn the same interest rates even if the market goes down.
Nevertheless, this very advantage of fixed deposits over mutual funds can actually turn out to be their great disadvantage. If the market goes up mutual funds will give more returns accordingly, but your FD will continue to yield in the same old rate. So, the actual question becomes, whether there is any chance of the Indian market going up in near future, especially following the recent recession? Yes, there is. At least, we think so. Market researches and predictions indicate that the Indian money market will go up in 2013, may get stagnant for a while in 2014, then taking another upward curve.
Mutual Funds Manager’s Recommendation: For longer tenures, mutual funds are as good as fixed deposits, if not better. 2. Comparison between mutual funds & fixed deposits: Inflation adjustment Inflation adjustment is a very important point while comparing mutual funds and fixed deposits. FDs don’t come with inflation adjustment guarantees, and if the interest rate is lower than the inflation rate, you actually end up losing the value of your money. In the FY 2011-12, the inflation rate in India was 7%, while the interest rate for around 1 year tenure was something around 7% as well [6. % for ICICI and HDFC banks, 6. 75% for Citibank and HSBC, 7. 10% for Axis and Yes Bank and so on. Higher rates are there, but for lump-sum investments like 1 crore. ]. Thus, if you have invested in bank FDs for the last FY, you either failed to beat inflation or ended up with minimal inflation adjusted positive returns. On the other hand, at least half a dozen mutual funds yielded returns greater than 8% (some as high as 12-14%), thereby giving you handsome inflation adjusted returns. Usually, mutual funds outrun inflation and always give positive, real returns.
Mutual Funds Manager’s Recommendation: Unless your fixed deposits give high interest rates like 9-9. 5%, mutual funds are better. 3. Mutual funds and fixed deposits: Capital appreciation When it come to capital appreciation, mutual funds are better than fixed deposits, because of the equity investment. In longer time periods, market changes result in increasing interest rates. And, your mutual funds manager is there with all the expertise and professionalism to ensure a better capital appreciation. Mutual Funds Manager’s Recommendation: Debt funds. No second thought. 4. Mutual funds or fixed deposits, which one is more liquid?
In terms of liquidity, these days both fixed deposits and mutual funds are almost same. Fixed deposits are actually meant for long lock in periods, but most banks allow premature withdrawals with a nominal penalty (usually 1%). The interest rate calculation for bank fixed deposit withdrawals is done on how long the money was parked. Mutual funds are equally liquid; you can take out any number of units within a couple of days. The return for premature withdrawal of mutual funds units is done on the prevalent NAV of the fund. Usually, there is an exit load of 1% for premature withdrawals before 1 year.
Mutual Funds Manager’s Recommendation: Almost equal. For premature withdrawals beyond 1 year, mutual funds are slightly better because of nil exit load. 5. Risk factor of mutual funds and fixed deposits The only reason why most investors prefer fixed deposits to debt mutual funds is the assured return of the capital. On the other hands, returns from investments in mutual funds are subject to the volatility of the market, and may result in low or even negative returns. An investor should be wise enough to judge the quality of the investment instrument and thereby minimizing risk factors.
Mutual Funds Manager’s Recommendation: For an extremely risk averse investor, fixed deposits are the only risk-free investment options. However, less risk means less return. Now, you decide! 6. Cost of investments in mutual funds and bank fixed deposits Investing in bank fixed deposits costs nothing. On the other hand, there is a minimum charge for mutual funds investments management and fund distribution, borne by the investor irrespective of returns. In other words, no matter whether your return on mutual funds investments is positive or negative, you have to bear an expense as the fees of fund management.
Sometimes, entry loads are there as well, but quite rarely. Mutual Funds Manager’s Recommendation: Fixed deposits, since they have no entry load or management charges. 7. Tax benefits of debt mutual funds and bank fixed deposits Fixed deposits interests are considered incomes and come under income taxes (if you are taxable, of course). Moreover, there is a TDS (Tax Deducted at Source) at the rate of 10. 3% p. a. if your total cumulative interest on all FD is more than Rs. 10,000 in any financial year. Similarly, short term capital gains of debt funds are considered income and are accordingly taxable.
For long term capital gains, tax is 10% without indexation or 20% with indexation. However, dividends received on debt mutual funds are tax free. Mutual Funds Manager’s Recommendation: Mutual funds are better than fixed deposits in terms of tax benefits, unless the latter offers any special scheme that is exempted from IT. So, should you invest in mutual funds or fixed deposits? We repeat, this decision is yours. If you are young and come from the average middle and upper middle class (at least), you can supposedly take more risk and should go for investing in mutual funds.
Mutual Fund:Mutual funds are investment companies that pool money from investors at large and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies. In this your amount is invested in different companies according to percentage ratio. Below are our best reading on mutual fund: * What Mutual Fund do with investor’s Money * Concept of Mutual Funds * Benefits of Mutual Fund * What is Net Asset Value (NAV) * What Is Mutual Fund? * Post Office FD Vs Mutual Fund * Mutual Funds vs portfolio management
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify. On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the money you invest, is in turn invested by the manager, on your behalf, as per the investment strategy specified for the scheme. The profit, if any, less expenses of the manager, is reflected in the NAV or distributed as income. Likewise, loss, if any, with the expenses, is to be borne by you. Bank fixed deposits are more stringently regulated than are companies.
They even operate under stricter requirements regarding Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) mandated by RBI. While the above are causes for comfort, bank deposits too are subject to default risk. However, given the political and economic impact of bank defaults, the Government as well as Reserve Bank of India (RBI) try to ensure that banks do not fail. Further, bank deposits up to Rs 1 lakh are protected by the Deposit Insurance and Credit Guarantee Corporation (DICGC), so long as the bank has paid the required insurance premium of 5 paise per annum for every Rs 100 of deposits.
The monetary ceiling of Rs 1 lakh is for all the deposits in all the branches of a bank, held by the depositor in the same capacity and right. Please Note: Bank fixed deposit is completely secure and gives a fixed return – the interest earned is taxable. Mutual Fund debt instruments issued by corporates, banks, rbi. They are not completely secure (very little risk) the risk is mostly to returns since the return is not absolutely fixed, however returns are taxfree in the hands of the investor. Invest for long term in mutual fund SIP for more profit.
What is meant by long term investment? Does it mean that buying at any price and wait for 3-4 years? Think twice. Give importance to Value; Give importance to Growth. Give importance to Price; these values are much more important statistics than Investment duration. Quote of the day: “A long term investment is like marriage; medium term investing is like an extra-marital affair and intra-day trading is like that risky one-night stand. ” Best Reading.
After several years, investors are finding that fixed deposit rates are climbing to respectable levels. While 90-day bank deposits are offering around 5 per cent returns, one-year deposits are yielding 7-8 per cent. As far as mutual funds are concerned, though the future of income funds, which invest in medium-and long-term debt papers, seems to be uncertain, short-term debt funds are giving returns in excess of 6. 5 per cent. On a post-tax basis, debt schemes – fixed-maturity plans in particular – seem to be the best option for investors looking for steady returns.
Funds beat banks Even as banks are luring investors with higher fixed-deposit rates, mutual funds seem to be steeling a march over them with FMPs. The total assets under management under these schemes have nearly doubled this year. At the end of July, these schemes had a combined corpus of Rs 28,571 crore (Rs 285. 71 billion). According to industry sources, in August alone, 14 FMPs have so far been launched with varying maturity and the total collection is expected to be at least around Rs 4,000 crore (Rs 40 billion).
The AMCs that have launched FMPs this month include Reliance, ABN AMRO, Principal, HSBC, UTI, HDFC, LIC, Prudential ICICI, JM Financial, DBS Chola and SBI. Essentially targeted at corporate and high networth investors, FMPs combine the tax efficiency of mutual funds with the safety of fixed deposits. The current rates on FMPs are as attractive as bank deposit rates and, thanks to the lower taxes on mutual funds, the post-tax returns on FMPs are better. Currently, 90-day FMPs are offering around 6. 85-7. 10 per cent, while one-year FMPs are generating around 8. 0 per cent pre-tax returns. HDFC Mutual’s 26-month FMP yields 8. 45 per cent for corporate investors and 8. 10 per cent for retail investors.
These schemes usually come with a quarterly or annual term, and the shorter-term schemes are a huge hit with corporate investors, who usually seek to lower the tax incidence. Mutual funds charge as low as 5-10 basis points as expenses, which is abysmally low. Even for retail investors in the top income tax bracket, these schemes make sense. The tax edge As dividends of mutual funds attract only a dividend distribution tax of 22. 4 per cent for corporates and 14. 03 per cent for individual investors vis-? -vis interest on deposits and corporate bonds, charged at the marginal income tax rate, mutual funds give better post-tax returns. “High networth individuals have a lot of appetite for these schemes as they generate significantly higher post-tax returns,” says Sameer Kamdar, national head – mutual funds, Mata Securities. Furthermore, income from mutual fund units – held for more than a year – is deemed to be ‘capital gains’ and, hence, qualifies for indexation benefit.
This reduces the tax incidence even more. Thus, while a 8. 1 per cent, one-year FMP would yield a post-tax return of 7. 2 per cent for an individual investor in the top income tax bracket (if he opts for the growth plan), a bank fixed-deposit offering a similar rate would yield only 5. 37 per cent net of tax. Even if you opt for the dividend plan, which is less tax-efficient compared to the growth plan, for more than one-year time horizon, you would come up with a post-tax return of 6. 96 per cent. The post-tax returns indicated above are based an indexation rate of 4. per cent. For the uninitiated, indexation is a method wherein returns are deflated to the extent of inflation. The tax is calculated only on the inflation index-adjusted returns. The idea is that tax on long-term capital gains must be charged only on the real returns earned by an investor. The inflation index is published by the income-tax department every year. Similarly, 90-day FMPs, which offer 7 per cent, would yield a post-tax return of 6. 01 per cent. Currently, JM Mutual and LIC are offering rates upwards of 7 per cent. The risk factor
Though FMPs are projecting fairly high yields, these are only indicative returns. They produce predictable returns over the desired timeframe since the maturity of the portfolio matches the tenure of fund schemes. Unlike other schemes that suffer from volatility and, hence, risk of erosion in asset value, an FMP – structured as closed-end funds – carries no interest rate risk. Whether yields rise or fall, the asset value of these schemes is protected as deposits/ bonds are held to maturity. Still, they do not guarantee returns as bank deposits – where the interest is assured – do.
Though FMPs have delivered the returns they have indicated so far, there could be a risk of asset-liability mismatch, and the investor may not finally get exactly the indicated yield. Says Dhirendra Kumar, chief executive officer of Value Research, a Delhi-based mutual fund tracking firm, “Since there is no guarantee on the returns that funds give, there is a risk that investors may or may not eventually get the returns indicated even in case of FMPs, which are otherwise quite predictable. ” Besides, if you lock in funds in an FMP you don’t have the option of liquidating it prematurely.
But in case of bank deposits, you can withdraw your money without any penalty. However, the interest rate you earn on the deposit would be based on the period the money is invested for. For instance, if you break a one-year deposit after three months, you would be entitled to the interest rate applicable for the three-month deposit – and not the one-year rate. In fact, since bank deposits can be withdrawn without any penalty, it is an ideal time for investors to close their old deposit accounts yielding lower returns and renew them at the prevailing rates. Other debt funds
With uncertainty on interest rates receding, debt markets have rallied over the past one month. The 10-year benchmark yield has declined from 8. 5 per cent in mid-July to 7. 91 per cent now, and this has propped up the returns on debt fund schemes. Most categories of debt funds have delivered returns in excess of 6 per cent. Particularly, medium-term gilt and debt funds have generated over 10 per cent returns. Should you then begin to relook at income funds? May be, not yet. Fund managers warn that this kind of returns may not be sustainable. On the contrary, the debt market rally looks overdone and the market may be in for some correction.
And if that happens, income funds may be back to square one. Moreover, the risk-return factor, today, is strongly in favour of short-term funds. “The return differential between medium-term and short-term debt funds is quite narrow, and the choice must be obvious given that short-term funds offer far greater stability and slightly lower returns,” says Kumar. Over the past one-month, short-term funds have seen a surge in returns too. This category has given an average return of 7. 2 per cent, which again compares favourably with bank deposits on a tax-adjusted basis.