Personal Finance Blog- India V 2.0: FD Vs Debt Funds

( Warning :- This article is loaded with "Hindsight bias")

I have been an avid saver and investor over the last decade. I have immensely benefited from my saving and investment habit. Looking back, I think I could have done better in these areas. ( Not an exhaustive list but the things that are on top of my mind at this point of time)

1. I should have "fully loaded" my PPF account from first year.

I opened a PPF account 15 years ago( good decision). But I didn't fully invest into it every year. During the initial years, I kept PPF account active by doing some minimum investment. NSC or ELSS was my preferred choice for parking the money. The reason being "15 years in PPF" looked "too long " for me.

I probably didn't understand the power of compounding and also that PPF is more tax efficient than NSC.

This mistake was corrected a few years back and now the PPF account is extended for the next 5 years :-).

2. Choosing growth option in Equity fund.

During initial investment years I thought , Dividends from equity funds was the most efficient way of "profit booking" a.k.a risk mitigation and it was better than growth plan. But didn't realize that in effect , dividends also broke compounding and selling units of growth option was the best way to book profits , if at all needed.

Now, most of my Equity MF investments are under growth option ( Direct plan- learn more)

3. Should have avoided more money in tax inefficient FD.

Bank FDs were my favourite investment to start with.

FDs are the least efficient way of investing for people in higher tax bracket. It doesn't help to beat inflation and no indexation benefit is available for FD investments.Having all your debt investments in FD is tax inefficient.

Of late, I use debt vehicles that defer taxation till withdrawal.

4. Having too many accounts.

I used to open one SB account whenever I switched jobs and wanted to hold all the five star funds ! Attractive bank FD rate hoardings led to many banks for opening FDs.

Having too many accounts eother it be SB, FD, demat or MF folio makes life difficult for you. Simple is always better!

Realising this, started closing many accounts and consolidating folios. Still some more work left here!.

Fixed Deposits or Debt Funds??-The main difference for a person in high income tax treatment lies in tax benefit .

1. The Return from FD is completely taxable. i.e the interest income is added the income of a person and he/she should pay tax as per their tax bracket.

2. As far as debt funds are concerned , the returns are classified as Long capital gains for investments of over 12-months and taxed as follows.

a.10 per cent without indexation or

b.20 per cent with indexation ( refer document page 97, for indexation)

Illustration

1. X invests 100000 in FD on 15 Apr 2009 and Matures on 14 Apr 2010 with value 108500.Income is 8500. If X falls in 30% tax bracket , 8500 will be taxed at 30%.

2. X invests 100000 in Debt fund on 15 Apr 2009 and Matures on 14 Apr 2010 with value 108500.

Option 1

a. Flat 10% on 8500 without indexation.

b. From the above chart indexation is roughly 12% ( 711 vs 632) and the returns are actually negative ( So,no tax)

By in investing in end of March of an year for 370 days or so will entail a person for double indexation benefit!

All funds that are not classified as Equity or Equity balanced funds will be covered under the aforesaid tax treatment. That includes Fund of funds, Gold ETFs, Global Equity funds et all.

A few more links on the same topic for reference :-