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FD is dead, Long live Medium Term Funds

Posted By: Admin

Have you ever thought about Fixed Deposit in which Interest rates are low and it is taxed at your slab rate?  If your slab rate is 30%, then sizeable part of your returns will be paid to the tax department. Obviously it is not the best option for investors. 

So what's the solution for people who want FD like returns( predictable and not volatile) with lower tax incidence  ?  

 Welcome Medium term debt funds.

Let’s have a look about medium term debt funds.

 A person wanting to park his money for tenure of 3 to 4 years, can look at medium term debt funds. This type of fund will invest in bonds, debentures, government related securities and other debt related instruments( very similar in character to your FDs). These funds are exposed to interest rate risk, default risk & credit risk. Compared to FD the interest will be slightly higher after taxation. These funds lend money to companies through bonds & debentures for a higher interest rate where the maturity of the security will be around 3 to 5 years. The fund Manager will invest as per the credit ratings of the security. 

Taxation - 

As these are debt funds. If the holding is less than three years it is considered as short term capital gain, where the gain is added to the tax slab, If the fund is held for more than three years it is considered as long term capital gain which is taxed at 20% with indexation benefit. 

Let’s have an example – If a person has invested each Rs.10 Lakhs by the financial year 2017-2018 in both FD and medium Term Debt fund and redeemed at 2020-2021. The taxation will be as per the below table.

 

 

Description

FD at SBI fixed deposit

Medium Term Debt Funds

Invested

10,00,000

10,00,000

No of Years

3

3

Rate of Return

5.10%

7%

Future Value

                      11,60,936 

                              12,25,043 

Capital gain

                        1,60,936 

                                2,25,043 

Taxation

As per tax slab 30% 

20% with indexation

Taxable Amount

                            48,281 

                                  23,685 

 

Conclusion – 

Although the medium term debt funds are not guaranteed as compared to FDs, we believe that if one is a 30% tax investor and has a 3 year + tenure and does not require regular income from his FDs, then Medium Term Funds would be a better option than FD. 

Safe Harbor  : Mutual Fund investments are subject to market risks. Investors are requested to do thorough Due diligence before investing in them.  The name of the scheme and the  past performance have no bearing on the future performance of the scheme. There is no guarantee that the principal or the interest of the investment will remain preserved or guaranteed. 

By Narayanan Narasimhan

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