The proposals put forward by the Finance Minister while presenting the Union Budget 2023-2024 bode well for the taxpayers. One of the key highlights of the presentation was the announcement of a new savings scheme for women or girls. The Mahila Samman Savings Certificate (MSSC), which is a fixed deposit scheme, will offer an interest rate of 7.5 percent per annum. The interest rate on FD will be applicable for deposits up to ₹2 Lakhs and a period of 2 years.
Over the last few quarters, fixed deposit interest rates have been on the upswing. This recent proposal is expected to further encourage banks to hike interest rates on FDs to stay ahead of the competition. Additionally, this presents risk-averse investors with a new dilemma – should they leverage the rising interest rates on FDs, or go with short-duration funds?
Short-duration funds have recently been the go-to investment vehicle for investors with a low-risk appetite and a short-term investment horizon. These are debt-oriented mutual funds with a maturity period of less than three years. As fixed-income securities offer a steady interest income while reducing the risk factor, investors have preferred short-duration funds over the last decade.
Fixed deposits, on the other hand, have been the preferred investment vehicle for Indian households for decades. However, over the last two decades, interest rates on FDs have dwindled, and debt mutual funds were able to cash in on this opportunity.
Now that financial institutions offer attractive interest rates on FDs – on par with short-duration funds, how can you maximise your investment returns? Let us take a closer look.
To compare the two investment vehicles, we have to consider four parameters – risk, returns, liquidity, and investment expenses.
In terms of risk, fixed deposits are low-risk investment options, as capital safety is assured by the bank. Even if the bank defaults – which is extremely rare, you will receive up to ₹5 Lakhs (principal and interest combined).
On the other hand, short-duration funds invest in fixed-income securities, subject to market risks. Thus, there is no guarantee of capital safety, and these carry low-to-moderate risk. Furthermore, the risks associated with short-duration funds include credit risk and interest risk. While these funds may be relatively immune to interest rate risks due to the short maturity of underlying assets, they carry higher credit risk than other instruments.
It is important that you factor in the risks while making your investment decision.
In the last decade, short-duration funds have offered higher returns. This was primarily due to the declining FD interest rates. At the same time, short-duration funds provided better annualised returns, making them highly attractive to investors with a short-term investment horizon.
However, with financial institutions providing higher interest rates on FDs, both investment instruments now offer similar returns. You can expect a variable yield of 7-9% with short-duration funds, while FDs offer an RoR of 6-9%.
This is one area where short-duration funds outpoint fixed deposits. The liquidity of short-duration funds is higher compared to fixed deposits. You can easily withdraw funds, as these are open-ended. However, in the case of fixed deposits, the financial institution levies a penalty charge if you withdraw the amount prematurely. This makes short-duration funds an excellent investment option for investors who require liquidity.
While this isn’t a significant amount, you must know that you are charged a nominal expense ratio for short-duration funds. However, you do not have to pay any management costs in fixed deposits.
Additionally, you should be aware of the taxation on short-duration funds and fixed deposits. The short-term capital gains on short-duration funds are taxed according to the investor’s slab rate. Similarly, in the case of FDs, the interest earned is added to the investor’s income annually, and is taxed according to the investor’s tax slab. However, short-duration funds offer the benefit of indexation, which adjusts the cost of investment for inflation.
For these reasons, in recent years, short-duration funds have outperformed fixed deposits. They have traditionally provided better RoI, high liquidity, and better taxation benefits. However, with the rising interest rates on FDs, fixed deposits are once again gaining momentum. Furthermore, financial institutions are now offering special interest rates with odd tenures.
With RBI increasing the repo rate last month (February) by 25 basis points, banks have also hiked interest rates on FDs. Financial institutions like Bajaj Finance now offer FD interest rates of up to 8.20 percent per annum. Thus, FDs provide a guaranteed return on investment, low risk, and tax benefits under Section 80C.
Before making a decision, investors must consider their investment objectives, risk tolerance, and investment horizon. A balanced portfolio with both short-duration funds and fixed deposits can offer the benefits of both investment options while minimising the risks.
Disclaimer: This article is published in association with Bajaj Finserv and not created by TNM Editorial.
