Fixed Deposits Vs Debt Mutual Funds: Which is better?

Fixed Deposits Vs Debt Mutual Funds : Which is better ?

When it comes to financial investments, most individuals are averse to taking risks.

Who would want to lose their hard-earned savings due to misinformed financial decisions?

Most prefer guaranteed returns and avoid volatility. It is no wonder that a bulk of Indian household savings are in bank fixed deposits.

Those who venture out in search of higher returns, fall for Ponzi schemes that promise “high return on capital with no risk.” Thousands of crores of hard-earned money has been lost to chit-fund scams like those of the Rose Valley Group and Saradha Group.

Others may invest in corporate fixed deposits that offer a high interest rate, but these are not backed by strong financials or the management’s intent to repay. In the past, companies such as Unitech, Jaiprakash Associates and companies promoted by Yash Birla that have either delayed or defaulted on payment of interest or principal or both.

Sadly, most individuals are unaware of the benefits of mutual funds. While mutual funds offer several asset classes to choose from, debt mutual funds are a good alternative to bank fixed deposits. However, you need to choose wisely.

With declining fixed deposit rates, the interest in different investment avenues is growing. This article, outlines the key differences between fixed deposits and debt mutual funds while covering the common questions you may have about the two.

What are debt mutual funds? How are they different from fixed deposits?

Unlike fixed deposits, where the rate of interest is known before investment, debt mutual funds diversify your investment over money market securities such as commercial papers and certificate of deposits, government securities, corporate bonds or corporate deposits. The allocation to these securities depends on the investment objective of the scheme.

To put it simply, under fixed deposits, you directly invest your money with the issuer. In debt funds, you invest the money indirectly through the fund house. The fund manager decides in which securities to invest, keeping in mind the investment objective of the scheme and focusing on high risk-adjusted returns.

How do debt mutual funds work? Do they pay a fixed interest like fixed deposits?

While fixed deposits either pay or accumulate the interest at a set date, the return of debt mutual funds is represented by their Net Asset Value (NAV).

As the underlying securities are traded in the market, similar to stocks, the value fluctuates depending on the liquidity and the direction of interest rate. Thus, when interest rates rise up, the value of the bonds and in turn your NAV falls. When rates head lower, the reverse happens. Thus, when RBI cuts interest rate, the value of the debt fund investment is expected to increase and earn a higher return.

As these are interest bearing securities, the yearly interest is divided by 365 (no. of days in the year), and the debt fund’s NAV goes up daily by this small amount.

Under debt funds, there are dividend options also available, which can be monthly, quarterly, or yearly. Therefore, similar to the interest pay out of fixed deposits, you may choose one of these options if you are looking for regular income. Please note, that the dividends paid out are post deduction of dividend distribution tax (DDT) of 28.84% (including surcharge and cess). Hence, this option is beneficial only if you are in the highest tax bracket.

Do debt mutual funds earn a higher return than bank fixed deposits?

There isn’t a straight answer to this question. As explained earlier, the returns of debt mutual funds are market linked. Therefore, the returns vary based on the schemes investment mandate, prevailing market conditions, and tax regime.

Schemes that invest in money market instruments or debt securities with a maturity period of a few days to some months, such as ultra-short term funds or liquid funds, carry a low risk; hence, the returns too may be lower. However, certain schemes in the category are able to deliver a higher return than bank FDs if the market conditions are conducive.

Short-term debt schemes invest in maturity assets of up to 1 year or more. Here the returns, though higher, may be more volatile than liquid schemes. Over a period of 2-3 years, most short-term debt schemes have the potential to deliver a higher return than bank FDs.

Income funds invest in securities of various maturities. Under most such schemes the portfolio is skewed to instruments with longer maturity. Income funds and similar long-term debt funds are more volatile, and the interest rate cycle plays a crucial role. In a period of rising interest rates, debt funds that invest in longer term securities may not offer the best returns; hence, these may trail the returns of bank deposits. However, in a falling interest rate scenario, these same schemes will be able to deliver high returns on investment.

What about the tax implications?

Debt mutual funds and bank fixed deposits are taxed differently.

The interest earned on bank fixed deposits are added to your total income (under the head ‘income from other sources’) and taxed as per your income tax slab. While in the case of debt mutual funds, if you redeem your investment before three years, the gains (also known as Short Term Capital Gains (STCG)) are added to your income and taxed accordingly.

For redemption of units which are held for a period of three years or more, the Long Term Capital Gains (LTCG) are taxed at a rate of 20% with indexation. The indexation benefit, aids to lower the tax impact, and is useful, especially for those in the higher tax brackets… and this is where debt funds score over bank fixed deposits. Due to a lower tax on investments greater than 3 years the debt fund tend to score a higher post-tax return as compared to bank deposits.

It is always important to keep up-to-date with the prevailing tax laws. If the Government changes the tax rules – like it did in 2014 – the benefits may get impacted. Earlier, withdrawal from debt funds attracted LTCG tax of either 10% (without indexation) or 20% (with indexation) and the holding period to qualify as long term was just 1 year.

What are the risks associated with debt mutual funds?

Debt funds primarily run two risks: the interest rate risk and the credit risk.

The market value of tradable securities held in a debt fund drops when the interest rates in the economy rise, and as a result, the Net Asset Value (NAV) of a fund drops. Since securities are redeemed at par value on maturity, those who can hold out until maturity don’t suffer much, but speculators who try to time interest rate movements do.

The credit risk, or risk of default, is a much bigger concern for debt fund houses. This is because, if the company issuing securities goes belly up, debt funds incur losses that can’t be recovered easily. Therefore, it is essential to check if your fund is investing in highly rated debt securities. Low rated debt securities offer a higher interest rate, but with higher risk.

Credit opportunity funds that adopt an accrual strategy benefit from this, with an increased credit risk to generate a higher yield. Schemes that have a high concentration of low quality assets should be clearly avoided. Liquidity too, is a cause of concern in low-rated debt securities. It can get worse if the credit rating deteriorates and the fund manager is unable to sell his holdings.

In the past, JPMorgan India Short Term Income Fund and JPMorgan India Treasury Fund bore the brunt of its corporate debt holding in Amtek Auto. The Amtek Auto security was de-rated to junk status, which led to severe mark-to-market losses for the fund. Due to the lack of buyers, the fund was unable to sell its holding.

At the same time, it is important to note that fixed deposits too are not devoid of risk. While your investments in well-known banks may be relatively safe, you should avoid entrusting your hard-earned money to shady and not-so-strong co-operative banks. Many cooperative banks in India have gone bust in the past; hence, it is best to stay away.

If you are opting for a corporate fixed deposit of an NBFC or others, due diligence is critical before parking your hard-earned money. Corporate FDs are not guaranteed investments; hence, you need to check the credit rating and financials of the company before investing.

Where should you invest—Debt mutual funds or fixed deposits?

Remember, compared to banks FDs and some Small Saving Schemes, the rates for which have been a downhill, investing in debt mutual funds can prove more rewarding and tax efficient.

But you ought to take enough care when selecting winning debt mutual fund schemes for your investment portfolio, because debt funds aren’t risk-free. It is therefore suggested that you should seek guidance of your financial advisor before you invest in any debt fund.

On the other hand, if you don’t have a stomach for risk and prefer stable and guaranteed returns, then stick to fixed deposits. Open an account with reputed private or public sector banks where the risk of going bust is low.

In my view it would be imprudent to invest at the longer end of the yield curve, which is in long-term debt funds holding longer maturity debt papers. It is vital to note that most of the rally has already been captured at the longer end of the yield curve.

Going forward, if RBI increases policy rates by any chance (enabled by the change in monetary policy stance from ‘accommodative’ to ‘neutral’) and if inflation pops up its ugly head, it could be perilous for your investments in long-term debt funds.

So, it would be better to deploy your hard earned money in short-term debt funds if you’re risk averse, but ensure you’re giving due consideration to your investment time horizon.

For an investment horizon of upto 2 years, consider investing in short-term debt funds.

If you have an investment horizon of 3 to 6 months, ultra-short term funds (also known as liquid plus funds) would be the most suitable.

And if you have an extreme short-term time horizon (of less than 3 months), you would be better-off investing in liquid funds.

Don't get swayed by distributors, relationship managers, or wealth managers who push hybrid mutual fund schemes such as Monthly Income Plans (MIPs) or Equity Savings Schemes (ESSs), or balanced funds as alternatives. These schemes include an equity component in their endeavour of wealth creation, which may be unsuitable if you were to evaluate investment avenues against bank FDs, due to the high risk involved. When you invest, ascertain your risk profile prudently; so as to have suitable investment avenues in your portfolio.

WHAT IS STP

What is a STP?

Systematic Transfer Plan (STP) is a tool provided by Mutual Funds that help transfer money automatically between two schemes at a predefined frequency.

How it works?

Mr X had invested Rs 60 thousand in scheme A (Liquid – Debt Scheme). Now, he wants to transfer Rs 10 thousand every month in scheme B (an Equity scheme). With STP, he can invest in scheme B using his existing investment in scheme A, simply by following a one-time registration process.

Different Types of STP

Fixed – Transfers amount is fixed.

Capital appreciation – Transfers only profit amount

Flexi STP – Transfers variable amount based on liquidity

Strategies to use STP

Fixing liquidity problems 
Face liquidity problems but want to invest regularly? Simple, once you get money, invest lump sum amount in liquid scheme and start STP into an Equity scheme – it works like SIP.

Doing value based investing 
Rebalance the portfolio across assets based on market valuation, using STP. When markets look overpriced, start STP from equity scheme to liquid scheme and vice versa.

Managing asset allocation for goal based investing 
Investors who are nearing the goal either in term of amount and /or time can transfer investment from equity to liquid scheme using STP to manage portfolio volatility better.

Planning your tax savings better 
Let say you have liquidity issue and still want to invest in an ELSS, start an STP from an existing investment in equity scheme to an ELSS and save tax.

WHAT ARE THE BEST INVESTMENTS YOU HAVE EVER MADE ?

Reply to a question posed by a friend  .....

WHAT ARE THE BEST INVESTMENTS YOU HAVE EVER MADE ?

My Answer: 

The best investments I ever made was at the age of 28, though I regret for having started so late.

I some how got attracted to good books while I spent time on railway platforms waiting for the trains and could eventually manage to buy the following books:

1. Rich Dad Poor Dad by Robert Kiyosaki.

2. How to Avoid Loss and Earn Consistently in Stock Market by Prasenjit Paul

3. Value Investing and Behavioral Finance by Parag Parikh.

4. Intelligent Investor by Benjamin Graham.

These books introduced me to a complete new world, the world of value investing.

Today, I fully attribute my success in investing to the above books.

I followed the principles and practices of the great authors relentlessly and with full faith, which eventually helped me to build up a strong portfolio of diversified assets for myself with ease.

I am sure, I couldn't have done better by working hard or otherwise chasing money.

Now my aim is to help people gain the right knowledge about stocks, paper assets and to help them adapt the practices of value investing.

My suggestion to all my friends .... start investing as early as possible, the power of compounding helps in a big way to create wealth AND stick to appropriate asset allocation without greed and fear.

Nurture your investments as you nurture a plant or a child.

Happy Investing ...... May all my friends create wealth for themselves.

RAJIV KAPOOR
9839034761

3 STEPS GUIDE TO HELP YOU INVEST WHEN MARKETS AT RECORD HIGH

Retail investors eager to invest in equities are facing an age-old dilemma. With stock markets at record high i.e. Sensex at over 31,000 and Nifty near 9,700, many feel they may be timing the market wrong because a fall may be just around the corner.

However, history has shown otherwise. Nobody knows when markets will fall next, and staying invested gives you a far better chance of becoming wealthy. At least, it is better than waiting for that elusive bottom.

Here is a 3-step process that will help you start investments, even if markets are at their so-called peak.

1. The longer your time horizon, losses vanish

Unlike many traders or short-term investors looking to make a quick buck, retail investors today are of a different kind. They know that they are not traders.

Hence, they invest for the long-term i.e. 5 to 10 years. If you have a longer time-horizon, the level of the index will have very little bearing. If you choose to directly invest in fundamentally researched stocks, or indirectly through mutual funds and unit-linked plans, the possibility of losses falls sharply beyond a 7-year holding period.

This means your chance of recording a loss becomes infinitesimally low when your investments spends a large amount of time in the stock market. Of course, this doesn't mean you will get away by putting your money in get-rich-quick schemes!

2. Start with some, and then hike exposure

When kids are afraid of jumping into a swimming pool, we dip their toes to acclimatise them with water. Swimming comes easier once there is some confidence.

This is the same approach you should take if you are feeling hesitant. Stocks are the only asset that can beat inflation and gives solid risk-adjusted returns. However, your vision may be clouded because of Sensex@31K or Nifty@10k.

The simple thing to do is to take a small exposure, and then increase it. There are some financial products that have 20-30 percent exposure to stocks and then rest in fixed income.

If you are investing in stocks directly, allocate 5-10 percent of your money in blue-chip shares that preferably pay a perky dividend.

You will soon gain confidence, and invest more. If you are convinced about the fundamentals of a product or a stock, buy more when prices dip.

3. Markets hit highs, and then hit new highs

When the Sensex hit 6,000 level in 2000, many people doubted if markets were strong enough. By 2005, it was near 9,500. In 2006, it hit 14,000 mark before ending below.

Then came a period of lull, underlined by the fear mongering around the global financial crisis. The Sensex fell to multi-year lows, before slowing creeping up. By 2013, the Sensex was near 21,000 and today in 2017, Sensex @32000 is just round the corner.

As corporate earnings, investment inflows and economic reforms happen, markets have taken out new highs regularly.

So, the belief that this time market is at its 'peak' is probably a fear. Just like Virat Kohli is challenging Sachin Tendulkar's batting records, stock markets also challenge their old records and make new ones.

Imagine the plight of an investor who took out his money from equities when Sensex was at 2000! In 17 years, his money would have grown 5 times or even more. Do you want to be the investor who missed out?

Summary: Stop looking at index levels before you invest. Instead, your investment goals should dictate the nature and quantum of your investment.

LET ME BE SOLUTION TO ALL YOUR FINANCIAL WORRIES

Let me be solution to all your financial worries, anxieties, apprehensions and dilemma. All that is needed from you is your 10 minutes. Do you have those 10 minutes ?

Start SIP in Equity Mutual Funds for long term wealth creation.

Transact through most efficient, technologically upgraded platform with full control of all your investments on your finger tips. 

Take help of a qualified professional, who himself is a big investor and who is passionate to help you in your journey of wealth creation.

Rajiv Kapoor FCS

9839034761

Investment and Financial Advisor

MITIGATE YOUR RISKS BY INVESTING THROUGH STP MODE

MITIGATE YOUR RISKS BY INVESTING THROUGH STP MODE

The best way of investing a lump sum in equity funds is through an STP. But how long should an STP run? ………. Source Article by Dhirendra Kumar

For those who follow the commonsense rule of investing only gradually in equity mutual funds, investing large sums of money becomes a problem. Normally, gradual investing works out well when one is doing an SIP from a monthly income. Every month, a fixed sum flows into the investment, leading to cost averaging and eventual high returns. This pattern of investment often generates good returns quickly and investors who sticks with it for a couple of years become faithful followers of SIP investing.

The problem arises when they come into a big sum which is outside of their regularly scheduled inflow. This could be a bonus from an employer, or an asset sales, or maybe a very lucky pre-Diwali night. For anyone who has understood the efficacy of SIP, the right way to go about this kind of an investment is to put it into a liquid fund, and then do a monthly transfer from there. This regular transfer from one fund to another is called an STP (systematic transfer plan).

The sticky issue is the period over which to spread the investment. The STP could be done over anything from three or four months to many years and investors are frequently at a loss as to how many monthly installments to break up the investments into. Since there is no underlying inflow as in the case of a salary that feeds an SIP, this is entirely at the discretion of the investor.

The right way to decide is to stop and consider the motive behind investing a lump sum gradually, in bits and pieces instead of in one lot. Clearly, we do it so that we don't catch a market peak. Consider the example of someone who came into R20 lakh in December 2007 and then invested it all in an equity fund. In four months, the money would be reduced to less than R10 lakh. In some funds, could have gone down to R5 or 6 lakh. Such a person would never invest again. It would take about six years to break even.

However, suppose this investor had invested gradually over 12 months. In that case, only about a tenth of the money would lose a lot of its value. Overall, averaging over a year, the acquisition cost would be such that the investment would hardly ever be in a loss. Of course, I've taken an extreme example to illustrate the concept, one that takes shifts the investor from an all-time high peak to a low point. You could have started a little earlier, say in 2006 and then spread the investment over a longer period.

However, if you actually look back at the markets over the last decade, you will realise that while an STP generally helps one avoid a market peak and average costs, they're not a foolproof device. If the markets keep rising for many years, as they did from 2003 to 2008, and then fall sharply, then even an STP cannot eliminate losses. Equity is equity and there's no way of doing away all risk. However, based on what has happened over the last two decades in India, stretching an investment over two to three years is likely to capture enough of a market cycle to significantly reduce risk.

At the end of the day, the key question that an investor has to ask is the trade-off between the risk of short-term equity market gyrations and the long-term returns that one can generate from equity. A lump sum investment is weighed completely towards the former, while a period like two to three years is a better trade off. And as for cycles that are long as well as extreme, like the one from 2003 to 2008, those are like a natural calamity. You can prepare for them, but there's nothing that will make you 100% safe.

RAJIV KAPOOR

9839034761