FINANCE SPECIAL..... Shift from deposits to mutual funds

Shift from deposits to mutual funds

With low interest rates here to stay, it is time to study investment alternatives, says Dhirendra Kumar

It is highly likely that India is heading for lower interest rates in the years to come. A measly 2.5-3.5% on savings bank deposits and 5-7% on other deposits may become the norm.

Most Indian savers are heavily invested in bank fixed deposits(FD). Their earnings have fallen by 25% or more in the last three years. The solution is the mutual fund products that fit the bill perfectly. They not only give higher returns, but are also liable for a lower tax outgo, making the effective return very attractive. In fact, compared to FDs, the liquidity and the convenience are also superior, especially if you deal through the special apps that many funds have released for the purpose.

Sebi’s recent reorganisation of fund categories has made sure that the types of mutual funds that work well as substitutes for bank accounts are liquid funds and ultra-short duration funds. As they give predictable and stable returns with negligible volatility. Over the past year, liquid fund returns have been an average of 6.85% and for ultra-short duration fund, returns have been around 6.47%.

Convenience is another luring factor. Liquid funds can be invested in and redeemed through apps for many fund companies. You can redeem the investments and the money gets transferred to your savings account within five to 10 minutes. They allow you to earn interest that is 1.5 times that of savings accounts.

The benefits go much beyond a simple comparison of returns. The different taxation structure means there’s a bigger difference in post-tax returns. The tax difference arises from the fact that returns from FDs are classified as interest income while mutual fund returns are classified as capital gains. Under interest income, you have to pay tax every year for the what you have earned that year. If your total interest income from a bank exceed ₹10,000, then the bank also deducts TDS at 10%. This means that a part of your return is not available for compounding because it is taken out and paid as tax every year. There is a further advantage to the mutual fund option if you stay invested for more than three years. If you redeem after three years, then the gains are classified as long-term capital gains and are taxed after indexation. Essentially, you get taxed only on inflation adjusted returns. Again, this does not happen with FDs. Applying all these factors, a three year investment in a short-term fund will leave you with almost twice the returns as an FD over the same period, and with excellent liquidity.

With the payoff being huge, a lot of us could benefit from shifting away from FDtype products and towards mutual funds.

The author is the Founder and CEO of Value Research

TOI 27AUG18