Many Indian banks offer fixed deposit interest rates of up to 7 percent, in spite of the rising interstrate rate. Some private lenders offer FD rates as low as 8%. An investor who plans to invest upfront in lump sums is faced with a difficult task when central banks around the world are extremely hawkish.
Fixed deposits should be avoided if you have a longer time horizon, such as 3 years. Debt funds are more tax efficient for those who hold them for more than three years. In today’s market, interest rates are extremely high and almost at the apex. Short term FDs should be preferred as FDs can drop anytime the central bank adopts a more hawkish stance. A debt fund for the long term is also attractive because it offers 20 percent indexation. Long-term debt funds are available to those who fall in the higher income tax bracket. Bank FD is 100% risk-free, while debt mutual funds carry some risk, but the risk level is very low.
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Amit Gupta (MD at SAG Infotech) highlighted the income tax benefits available in debt mutual funds. He stated, “Interest through FFDs is taxable depending on your tax bracket. Your FD tax rate will remain the same if you fall within the 30% income tax bracket. Your effective tax rate will decrease if you hold debt funds for a minimum of three years. This is because the profits are subject to 20% tax. Indexation benefits, which reduce taxes further, are included in the long-term capital gains tax. Debt funds offer much higher post-tax returns for holding periods exceeding 3 years.
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SAG Infotech’s Amit Gupta stated that debt funds are financially sound, despite their poor past results. But, not all debt funds are created equal. Different types of debt funds react differently.
“Due to the rising rate scenario that is approaching its apex it is better for debt funds to have shorter term profiles. Amit Gupta stated that if more than one category is required, it could be a combination or sleek, low frequency bond funds and target maturities funds. These funds must be kept until maturity.
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CA Manish P Hingar (Founder of Fintoo) stated that Target Maturity Funds are a good choice for investors looking to make an investment in the rising interest rate environment. Target Maturity funds invest mainly in government securities, PSU bonds, and high-rated papers. The indexation benefit that the investors receive is also a tax advantage. Target-maturity funds are a great way to add value to your portfolio if you have a well-defined investment plan, seek predictability and can accept modest returns.
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Fintoo expert explained that bank FD account holders can maximize their return in rising interest rates. “Considering the rising rate scenario, the impact is not seen on fixed deposit with immediate effect, but most of the increase in interest rate has already been factored in, and banks tend to marginalize fixed deposit rates once the interest rate cycle cools off. Investors have the option to choose floating rate fixed deposits, as the interest rate rises with the increase in interest rates. However, investors should not opt for long-term floating fixed deposit options as they can suffer a drop in returns once the interest rates fall.
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Manish P. Hingar, however, suggested that bank depositors choose floating bank funds for short-term. He said, “It’s suggested to opt to Floating rate bank FDs only for a maximum period of 2 years. A longer investment tenure could expose an individual to falling interest rates. It is a good idea to invest in fixed-rate FDs with long-term rates when interest rates are high to lock in a higher rate for the long term.
Disclaimer: These views and recommendations are solely those of the individual analysts and personal finance companies. Before making any investment decision, we recommend that investors consult certified experts.