Both fixed deposits (FDs) and debt mutual funds are low risk investment financial instruments and were used to be seen as comparable investment options. But recently after demonetization, major Indian banks, in both public and private sector, have revised the interest rates they offer on FDs.

Country’s largest lender, State Bank of India (SBI), cut its interest rate on FDs to 6.90% for maturity period of 1 year and to 6.50% for maturity periods between 3 to 10 years, which is lowest in the industry now.

Whereas, return on debt mutual funds are usually around 7-9 % per annum. In such a scenario, parking your surplus cash in debt mutual funds is a wise investment.

List of 10 Debt Funds That Gave Better Returns Than FDs

Here’s the list of 10 debt funds that gave better returns than FDs in past :

ICICI Prudential MIP 25

This is a Monthly Income Plans (MIPs) type Debt Mutual Fund launched in March 30, 2004. It is debt fund with moderately low risk and have given a return of 10.29 % since its launch. Here’s the key features of ICICI Prudential MIP 25 :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 1460 Cr.
  • Age is nearly 14 years. So its performance can be easily judged.
  • Past 3 years and 5 years return is 8.8 % and 11.46 % per annum respectively.
  • Has consistently outperformed its benchmark Crisil MIP Blended since its launch.
  • The top portfolio holdings of the fund include 7.61 GOI May 9 2030, 7.95 Vedanta Ltd. Apr 22 2020, CBLO (CCIL), 7.6 ICICI Bank Ltd. Oct 7 2023, 2 Tata Steel Ltd. Apr 23 2022 etc.
  • The holdings are balanced across various sectors with maximum weightage given to Sovereign ( 54.4 % ).
  • Minimum SIP = ₹ 1000
  • Equity share = 25.1 %

L&T Short Term Income Fund

This is a Short Term Fund type Debt Mutual Fund launched in December 04, 2010. It is debt fund with low risk and have given a return of 8.89 % since its launch. Here’s the key features of L&T Short Term Income Fund :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 1156 Cr.
  • Age is nearly 7 years. So its performance can be easily judged.
  • Past 3 years and 5 years return is 8.78 % and 8.92 % per annum respectively
  • Has consistently outperformed its benchmark Crisil Short-Term Bond since its launch.
  • The top portfolio holdings of the fund include  8 Bharat Aluminium Co. Ltd. Jun 30 2020, Sprit Textiles Pvt Ltd., CBLO (CCIL), 8.45 Tata Power Renewable Energy Ltd. etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services ( 38.5 % ).
  • Minimum SIP = ₹ 1000
  • Equity share = 0 %

ICICI Prudential Long Term Plan 

This is a Dynamic bond type Debt Mutual Fund launched in January 20, 2010. It is debt fund with moderately low risk and have given a return of 9.78 % since its launch. Here’s the key features of ICICI Prudential Long Term Plan :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 3674 Cr.
  • Age is nearly 8 years. So its performance can be easily judged.
  • Past 3 years and 5 years return is 8.23 % and 11 % per annum respectively
  • Has consistently outperformed its benchmark BSE S&P 100 and NIFTY 50 since its launch.
  • The top portfolio holdings of the fund include 7.17 GOI Jan 8 2028, 7.88 GOI Mar 19 2030, CBLO (CCIL), Yes Bank Ltd. , 7.88 GOI Mar 19 2030 etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (42.3 %) followed by Sovereign ( 37.9 % ).
  • Minimum SIP = ₹ 1000
  • Equity share = 0 %

Franklin India Low Duration Fund

This is a  Ultra Short Term Fund type Debt Mutual Fund launched in July 26, 2010. It is fund with very low risk and have given a return of 9.38 % since its launch. Here’s the key features of Franklin India Low Duration Fund :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 5586 Cr.
  • Age is nearly 7 years. So its performance can be easily judged.
  • Past 3 years and 5 years return is 9.11 % and 9.44 % per annum respectively.
  • Has consistently outperformed its benchmark Crisil Short-Term Bond since its launch.
  • The top portfolio holdings of the fund include 9.2 DLF Home Developers Ltd. Nov 21 2019, Renew Power Ventures Pvt. Ltd., 12.25 DLF Ltd. Aug 10 2018, 8.4 Edelweiss Commodities Services Ltd etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (48.1 %).
  • Minimum SIP = ₹ 500
  • Equity share = 0 %

Franklin India Ultra Short Bond Fund

This is a Ultra Short Term Fund type Debt Mutual Fund launched in December 18, 2007. It is fund with very low risk and have given a return of 8.89 % since its launch. Here’s the key features of Franklin India Ultra Short Bond Fund :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 6979 Cr.
  • Age is nearly 10 years. So its performance can be easily judged.
  • Past 3 years and 5 years return is 9.11 % and 9.49 % per annum respectively.
  • Has consistently outperformed its benchmark Crisil Liquid since its launch.
  • The top portfolio holdings of the fund include Viom Networks Ltd., 8.4 Edelweiss Commodities Services Ltd., AU Financiers India Pvt Ltd, Tata Power Renewable Energy Ltd., 12.25 DLF Ltd. Aug 11 2017 etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (49.4 %).
  • Minimum SIP = ₹ 500
  • Equity share = 0 %

Franklin India Short Term Income Plan 

This is a Short Term Fund type Debt Mutual Fund launched in January 31, 2002. It is fund with low risk and have given a return of 8.34 % since its launch. Here’s the key features of Franklin India STIP :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 9280 Cr.
  • Age is nearly 16 years.  So its performance can be easily judged.
  • Past 3 years and 5 years return is 8.4 % and 9.25 % per annum respectively.
  • Has consistently outperformed its benchmark Crisil Short-Term Bond since its launch.
  • The top portfolio holdings of the fund include Dolvi Minerals And Metals Ltd., 13.15 Greenko Solar Energy Pvt.Ltd ., 9.5 Yes Bank Ltd., 9.2 DLF Home Developers Ltd. Nov 21 2019, Renew Power Ventures Pvt. Ltd. etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (32.1 %).
  • Minimum SIP = ₹ 500
  • Equity share = 0 %

Aditya Birla Sun Life MIP II – Wealth 25

This is a Monthly Income Plans (MIPs) type Debt Mutual Fund launched in May 22, 2004. It is debt fund with moderate risk and have given a return of 10.18 % since its launch. Here’s the key features of Aditya Birla Sun Life MIP II – Wealth 25 :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 2527 Cr.
  • Age is nearly 13 years.  So its performance can be easily judged.
  • Past 3 years and 5 years return is 9.23 % and 12.99 % per annum respectively.
  • Has consistently outperformed its benchmark CRISIL Hybrid 85+15 Conservative since its launch.
  • The top portfolio holdings of the fund include Reverse Repo, 8.13 GOI Jun 22 2045, 6.68 GOI Sep 17 2031, 8.56 Rajasthan SDL Jan 23 2023, 8.03 Idea Cellular Ltd. Jan 31 2022, CBLO (CCIL) etc.
  • The holdings are balanced across various sectors with maximum weightage given to Sovereign ( 44.5 % ) followed by Financial Services (28.5 %).
  • Minimum SIP = ₹ 1000
  • Equity share = 30.9 %

Franklin India Dynamic Accrual Fund 

This is a Credit Opportunities type Debt Mutual Fund and one of the oldest debt fund launched in March 5, 1997. It is debt fund with low risk and have given a return of 8.97 % since its launch. Here’s the key features of Franklin India Dynamic Accrual Fund :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 3008 Cr.
  • Age is nearly 20 years.  So its performance can be easily judged.
  • Past 3 years and 5 years return is 9.26 % and 9.06 % per annum respectively.
  • Has consistently outperformed its benchmark Crisil Composite Bond since its launch.
  • The top portfolio holdings of the fund include Pune Solapur Expressway Pvt Ltd., Dolvi Minerals And Metals Ltd., 9.5, Yes Bank Ltd., Essel Infraprojects Ltd., Aditya Birla Retail Ltd. etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (27.3 %).
  • Minimum SIP = ₹ 500
  • Equity share = 0 %

Aditya Birla Sun Life Medium Term Plan

This is a Credit Opportunities type Debt Mutual Fund launched in March 22, 2009. It is debt fund with low risk and have given a return of 9.07 % since its launch. Here’s the key features of Aditya Birla Sun Life Medium Term Plan :

  • This fund has been rated as a 5 star fund by Groww.
  • AUM of close to ₹ 11696 Cr.
  • Age is nearly 9 years.  So its performance can be easily judged.
  • Past 3 years and 5 years return is 8.76 % and 9.76 % per annum respectively.
  • Has consistently outperformed its benchmark Crisil AA ST Bond Index since its launch.
  • The top portfolio holdings of the fund include Piramal Finance Ltd., SP Imperial Star Pvt. Ltd., Sprit Textiles Pvt Ltd., Wadhawan Global Capital Pvt Ltd., RKN Retail Pvt. Ltd., 10 Prestige Estates Projects Ltd Jun 8 2022 etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (38.4 %).
  • Minimum SIP = ₹ 1000
  • Equity share = 0.4 %

Axis Income Fund

This is a Income type Debt Mutual Fund launched in March 30, 2012. It is debt fund with moderately low risk and have given a return of 10.29 % since its launch. Here’s the key features of Axis Income Fund :

  • This fund has been rated as a 4 star fund by Groww.
  • AUM of close to ₹ 425 Cr.
  • Age is nearly 6 years.  So its performance can be easily judged.
  • Past 3 years and 5 years return is 8.03 % and 8.82 % per annum respectively
  • Has consistently outperformed its benchmark Crisil Composite Bond since its launch.
  • The top portfolio holdings of the fund include 7.55 TI Financial Holdings Ltd. Feb 20 2020, Net Receivables/(Payable), 8.32 Reliance Jio Infocomm Ltd. Jul 8 2021, 9.2 ICICI Bank Ltd., 7.99 Tata Power Co. Ltd. Nov 16 2020 etc.
  • The holdings are balanced across various sectors with maximum weightage given to Financial Services (46.3 %).
  • Minimum SIP = ₹ 1000
  • Equity share = 0 %

Debt Funds vs Fixed Deposits

FDs are not just investments, they are a part of Indian tradition and culture. Our grandparents and parents have sworn by FDs for most of their lives. All bonuses went to FDs. Whenever they had to save money for a goal, they put it in an FD. It was the best option to earn on interest while ensuring capital protection.

Even most equity fund investors have certain amounts invested in FDs for their short-term and mid-term financial goals. But now, debt funds are becoming an increasingly widespread rival to the hallowed FD.

Owing to its familiarity and institutionalized nature of FDs, an average Indian taxpayer has more trust in FDs. However, it seems they are not the most popular long term investment anymore. This is due to the rising acceptance of mutual funds by investors with different investment goals.

Also, the declining interest rate regime and the excessive liquidity caused by last year’s demonetization have forced banks to reduce their FD interest rates to historic lows. This is in turn is forcing many retail investors to turn towards smarter investment alternatives like debt mutual funds.

Investment in debt mutual funds is much better option than parking your money in bank FDs. Lets look in major reasons for this conclusion :

Taxation

The big difference between this two low risk investment instruments is that of taxation. Taxation played very important role in deciding how much return you are earning on your investment.

In case of FDs

The interest earned from FDs is added to your annual income for taxation purposes. Hence, the tax rate on interest earned from FDs will depend on your  income tax slab, i.e. 5%, 20% or 30% on the interest received.

For example, if your annual income after including interest earned from your FDs falls within the 30% tax bracket, the interest component will attract 30 % income tax. Since many investors are in the top (30 per cent) tax bracket, this takes away a large chunk of their returns.

In case of Debt Funds

Taxes upon debt mutual funds are of two types depending upon the period for which they are held.These two types are:

Short-term Capital Gain tax : This is applicable on debt mutual funds held for a period of 36 months or less i.e. anything less than 3 years. In short-term capital gain tax, tax on funds is calculated as per income tax slab of the individual, i.e. 5%, 20% or 30% on the amount of gain.

Long-term Capital Gain tax : This is applicable on debt mutual funds held for a period of 36 months or more i.e. anything more than 3 years. In long-term capital gain tax, tax on funds is calculated at the rate of 20% with cost indexation on the amount of gain.

Indexation is the adjustment of your purchase price with respect to effect of inflation in an economy and helps you to pay low taxes on your capital gain.

For example, 

Particulars Fixed Deposits Debt Funds
Invested Sum ₹ 10 lakhs ₹ 10 lakhs
Return Rate 10 % 10 %
Lock-in Period 5 year 5 year
Fund worth at the end of tenure ₹ 15,00,000 ₹ 15,00,000
Inflation per year 8 % 8 %
Indexed Investment Sum ₹ 14,00,000
Taxed Amount ₹ 5,00,000 ₹ 1,00,000
Tax to be paid ₹ 1,50,000 ₹ 20,000
Possible returns after tax ₹ 3,50,000 ₹ 4,80,000

Thus, even if a bank FD and a debt fund generate same rate of return, the debt fund will still generate higher post-tax return, provided you come under 20% or 30% tax bracket and your investment horizon is more than 3 years.

Read moreTaxation on Mutual Funds in 2018: A Complete Guide

Tax Deducted at Source (TDS)

Apart from above mention taxation, Banks also deduct TDS on interest income from fixed deposits. It was introduced to collect tax at the source from where an individual’s income is generated.

As per the Income Tax Act, any company or person making a payment is required to deduct tax at source if the payment exceeds certain threshold limits. TDS has to be deducted at the rates prescribed by the tax department.

As a resident Indian, there will be no TDS when you sell/redeem your debt fund units. You are required to show the income and pay taxes, if any, when you file your returns. However, for a non-resident Indian, while the tax laws remain the same for capital gains, TDS will be deducted, at the applicable rates, at the time of redemption.

Liquidity

Turning to liquidity, open ended debt funds proceeds are credited within a period of 2-3 working days depending on factors such as whether an ECS mandate is registered. Fixed Deposits are also typically available at 1-2 day’s notice, but usually carry a penalty if they are redeemed before the maturity date.

Banks penalize premature withdrawal of FDs by paying lower interest rate than the original booked interest rate. Premature withdrawal is however not allowed in tax saving fixed deposits as they have a lock-in period of 5 years.

Most banks currently deduct 1% from the original booked rate or 1% from the original card rate applicable for the period for which the FD has been in force, whichever is lower. These may adversely impact your FD’s effective rate of return in case of pre-mature withdrawal during emergencies.

Debt mutual funds, other than Fixed Maturity Plans, do not restrict redemption. However, many funds charge exit loads, ranging from 0.25–1% of the redeemed amount, if they are redeemed within a pre-specified period. Such periods can range anywhere from 15 days to 6 months.

Ultra-short term and many short-term funds do not charge exit loads. Such debt funds will suit best to park your emergency fund.

Risk Associated

Bank FDs can be rightly considered as one of the safest avenues for parking your surpluses. The reason is that Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, guarantees all bank deposits of up to ₹ 1 lakh in the event of your bank’s failure. The coverage extends to all types of bank deposits, including fixed, savings, current and recurring deposits.

Debt funds are relatively less risky than equity funds, but they are not risk free like the way bank FDs are. Though they invest in government securities, money market instruments and corporate deposits, the investors are still exposed to risk of default or bankruptcy of concerned parties. This makes it more risky as compared to traditional Fixed Deposits.

But, risk is inherent to investing. Investments vary across the risk spectrum, but there is hardly any investment that’s entirely risk-free. The best thing about investing in mutual fund is that it provides you wide scope of investment option depending on your risk appetite. And still debt funds are best option for an investor with low risk appetite.

Returns on Investment

After demonetization, many banks lower the FD rates due to excessive liquidity. State Bank of India (SBI), for example, currently offers 6.9% for 1-year deposits, compared to 8% in 2015. For a 3-year deposit it is even lower at 6.25%. Current average for the short-term debt funds category is around 9.3% and you can expect return on debt mutual funds are around 8-11 % annually.

As the returns of debt funds demonstrate, you can beat the bank by investing in debt funds. Debt fund investors assume both credit risk (lending to riskier borrowers) and interest rate risk (the risk of bond prices falling when interest rates rise) and are hence compensated by higher returns.

Other Differences

Particulars Debt Mutual Fund Fixed Deposits
Investment tenure (minimum lock-in) 3 years 5 years
Expected Rate of Returns 8-11 % 6-8 %
Dividends YES NO
80-C tax exemption Up to 1.5 lakhs (for 5 year lock-in)
Types Many as per risk appetite Few options
Risk Level Low-level to Mid-level risks Minimal risk
Inflation-adaptability Power of compounding ensures inflation-beating returns Low adaptability to inflation
Liquidity Higher liquidity Low liquidity
Investment options Both SIP and lump-sum investment options available Only lump-sum investment
Early withdrawal Allowed with or without exit load depending on the debt fund type A penalty is levied to withdraw prematurely
Overall investment expenditure Fund house charges a fee – usually no more than 2.5 % for debt funds No management costs

Conclusion

Debt funds clearly outscore bank FDs in terms of returns, liquidity and tax treatment. Bank FDs outscore debt mutual funds only in terms of capital protection and certainty of returns. However, if debt funds are selected wisely, even these risks can be mitigated to a large extent.

For investment tenure of less than 3 years, both FDs and debt funds are taxed in same way and there is not much difference you can see in terms of returns on your investments. But for your regular allocation to debt, which will remain for more than 3 years, debt funds make a better choice thanks to their consistent long-term track record, tax efficiency and flexibility to shift.

Ultimately, you should weigh your decision on your risk appetite, time horizon and investment goals. As market looks positive in last few years and there is several prospects for economic growth in coming years with the announcement of Union Budget 2018, it makes more sense to opt for debt funds than fixed deposits.

But remember, don’t invest in debt funds without doing your homework. Performance track record along with scheme-specific attributes, portfolio credit quality, fund manager track record and expense ratios really do matter for investing in debt mutual funds.

To look at some of the best performing funds from every category of mutual funds, check out Groww 30 best mutual funds to invest in 2018.

Happy Investing!

Disclaimer: the views expressed here are of the author and do not reflect those of Groww.