Last Updated on April 12, 2017
Budget 2014 appears to have struck a cruel blow to debt mutual fund investors and distributors. Here is the latest version of the debt mutual fund vs. fixed deposit calculator to evaluate the utility of debt mutual funds.
Update: Ramesh Mangal pointed out an error in the tool and the graphs. So I have pull out this post briefly to correct the errors. Hope they are all gone! Sorry for the inconvenience.
The finance minister in his budget speech said,
“In the case of Mutual Funds, other than equity oriented funds, the capital gains arising on transfer of units held for more than a year is taxed at a concessional rate of 10% whereas direct investments in banks and other debt instruments attract a higher rate of tax. This allows tax arbitrage opportunity. This arbitrage has hardly benefited retail investors as their percentage is very small among such Mutual Fund investors. With a view to remove this tax arbitrage, I propose to increase the rate of tax on long-term capital gains from 10 percent to 20 percent on transfer of units of such funds. I also propose to increase the period of holding in respect of such units from 12 months to 36 months for this purpose”.
Does this mean fixed deposits are better than debt mutual funds? Not quite.
The government wants to remove the tax arbitrage that now exists for debt funds.
Note: When the finance minister said, “I propose to increase the rate of tax on long-term capital gains from 10 percent to 20 percent on transfer of units of such funds”, I assumed the 10% without indexation now becomes 20% without indexation and 20% with indexation.
This seems to be wrong. The 10% without indexation is no longer available. Only the 20% with indexation option is available.
This is good news. Please ignore the ‘without indexation’ curves (green) in the plots below.
Let us now find out which instrument is more beneficial and when. We will assume tax is paid only upon redemption for debt funds and indexation benefits are available at 20%.
Let us consider an investment of Rs. 10,000.
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9% (you can play with both rates in the calculator)
Tax Slab: 30%
Here I have assumed the cost inflation index increases each year by only 5%. If it is more, the benefit will be more.
For durations above 3 years, debt mutual funds still make sense for those in the 30% slab. With indexation, the gains are higher.
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9% (you can play with both rates in the calculator)
Tax Slab: 20%
Still makes sense to hold debt mutual funds since the indexation benefit still scores over FDs. Even without indexation, debt fund may do marginally better because of the 10.3% TDS by the bank.
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9% (you can play with both rates in the calculator)
Tax Slab: 10%
Obviously without indexation, debt funds cannot win. Indexation will in favour of even those in the 10% slab.
Verdict:
- For those in those 30% slab, debt funds are still good instruments for any requirement above 3 years. It does not matter if indexation option is available or not.
- For those in those 20% and 10% slabs, debt funds are still good instruments for any requirement above 3 years if indexation option is available (from what I seen on the web, it is available).
- These changes will not affect those invested in international equity funds much, provided they hold on to it for more than 3 years.
Download the debt mutual fund vs. fixed deposit comparator
🔥Enjoy massive discounts on our courses and robo-advisory tool! 🔥
Use our Robo-advisory Excel Tool for a start-to-finish financial plan! ⇐ More than 1000 investors and advisors use this!
- Follow us on Google News.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Join our YouTube Community and explore more than 1000 videos!
- Have a question? Subscribe to our newsletter with this form.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Explore the site! Search among our 2000+ articles for information and insight!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu gets a superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low volatility stock screeners.
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any paid articles, promotions, PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)