Debt funds vs FDs: Where should you park your finances?

Debt mutual funds can be a part of anyone's portfolio, be it an ultraconservative investor or aggressive one.

  • Money9
  • Updated On - June 13, 2021 / 07:16 PM IST

Indians have a fixation with fixed deposits (FDs) when it comes to parking their finances. It is a traditional investment tool that many consider being safe and risk-averse. But generating lower returns that are not even able to beat inflation is hampering many investors’ investment goals.

An alternative investment tool, debt mutual funds, could be a much better option to get good returns and diversify one’s portfolio.

Are fixed deposits really risk-averse?

The popularity of fixed deposits among a majority of Indian households owes to the notion of it being the safest investment tool. However, if closely analysed…FDs are not totally risk-averse.

“It is a misconception that FDs are risk-free. FDs not only have default risk but also other risks associated with them. First of all, FDs are not lucrative enough to meet the investment objective of beating inflation. Tax inefficiency and illiquidity are other risks that FDs are associated with,” says SRE Wealth’s co-founder and CEO, Kirtan Shah.

There exists another risk termed as interest rate risk in the case of FDs. If a person has invested in an FD at an interest rate existing today, the FD will be locked in for the same rates even if it goes up in the future.

Debt funds a better option

“In my opinion, when a person invests in one FD, his/her entire 100% money is kept in that one deposit. It means if something happens with that entity or institution there is too much at stake,” Shah says.

He further adds, “On the contrary, if a person invests in one debt mutual fund, that sums up to investing in 100 different FDs or bonds, that one particular fund is typically investing in. This brings down the concentration risk which is not in the case of an FD.”

Another benefit of investing in debt funds is that if a person is investing in them for over three years it will give an indexation advantage.

These funds are well placed for investors, provided the person is aware of the risk propensity, which suggests that the capital market value may keep moving up and down during the course of investment.

Debt mutual funds can be a part of anyone’s portfolio, be it an ultraconservative investor or aggressive one. There are around 16 different categories in debt mutual funds.

Because of so many products and schemes it offers, an investor can logically choose which among these categories he/she can build their fixed income.

Park FD money in debt mutual funds

Should an average investor, who has his money parked in FDs, consider putting that amount into debt mutual funds?

Shah advises that for the general public larger allocation of debt mutual funds is advisable. “By investing in funds like money market or short term debt mutual, while keeping your time horizon 2/3/5 years, like in FDs, you will able to beat inflation and generate many decent returns post-tax than in FDs”, he says.

Are debt mutual funds a viable option for all, even retired individuals?

Retired individuals do not have a lot of options available. Most of the post office schemes, LIC’s Pradhan Mantri Vaya Vandana Yojana also have a limit attached to them.

Shah says, “If the senior citizens have less than 30 lakh of investment to do then post office schemes and LIC schemes can be a much better option for them, rather than looking for debt mutual funds. For those retired individuals who do not have a solid corpus, it is not a favourable tool of investment, they should look at other investment tools.”

However, if the individual has a larger corpus to invest then there is a huge opportunity. One can invest in a debt mutual fund and opt for a systemative withdrawal plan. With this plan, the person will keep receiving money every month/ quarter, as he/she opts.

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