Amid Rising Interest Rates, Which Is Better For Regular Income Mutual Funds Or Bank FDs?

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Investment
oi-Shubham Kumar

| Published: Friday, July 29, 2022, 16:16 [IST]

As governments struggle with slowing economic growth and rising prices, inflation is on the rise globally and has become a source of concern. For a long time, inflation was ignored and dismissed as a passing occurrence by major economies. However, the recent development in the repo rate, which was hiked by the Reserve Bank of India (RBI) explains the impact of inflation on the economy. The repo rate was raised by the RBI by 40 basis points on May 4 and by another 50 basis points in June after a protracted period of low-interest rates. The Repo rate is the benchmark rate that dictates the direction of interest rates in the economy.

Bank FDs VS Mutual Funds

Coming to investing, when it comes to generating a steady income, bank deposits have always been among the most common investment options. Guaranteed income is one of the main benefits of bank savings, in addition to safety.

What about the income tax issue, though? When it comes to bank deposits, the interest income is simply added to the investors’ income and taxed in accordance with their individual tax slabs.
Financial experts advise systematic withdrawal plans (SWP) in debt mutual funds as a better option for investors, especially those in higher tax brackets, wanting to receive a regular income from a lump sum. This recommendation was suitable as earlier the interest rates were low, however, now the interest rates are rising and FDs look more promising.

However, this is also a fact that debt funds also provide the benefit of liquidity in the event that investors decide to leave, where Bank FD lacks behind. When interest rates decrease, the debt markets increase but in the current situation, it is against the Debt funds.

What is a systematic withdrawal strategy?

It is a feature that enables investors to regularly withdraw money from a mutual fund plan. Investors who want income at regular times frequently choose this option.
 
 SWPs typically come in two options. In the first option, the investor specifies a fixed sum that is withheld at predetermined intervals, such as monthly, quarterly, etc. In the alternative, investors might take monthly or quarterly distributions of the appreciated amount.

Why SWPs are more tax-inefficient than FDs?
 
Debt fund investments are only regarded as long-term if they are kept for a period of time greater than three years. At the moment, debt fund long-term capital gains are subject to a 20% tax. Investors profit from indexation on their initial investment, nevertheless. In other words, taxes are applied to the initial investment after taking inflation into account. After accounting for inflation, the original investment cost increases, resulting in a small amount of long-term capital gains tax.

However, short-term gains are taxed in accordance with the investor’s tax bracket if debt mutual fund investments are redeemed or sold before three years have passed. Even in the first three years of investment, SWP in debt funds is more tax-efficient than fixed deposits.

What Should Investors Do Amid Rising Interest Rates?

Both the debt and equity markets are impacted by rising interest rates and Bank FD for sure. Maintaining diversification is important, as is asset allocation. 
 
 You will be better off investing in debt funds that buy shorter maturity bond papers on the debt side. Debt funds with shorter maturities perform better when interest rates are rising. This is so because shorter-maturity papers are less affected by interest rate increases.
Thus, you can choose liquid or low-duration funds if you want to invest for a very short time, like a few months. However, long-term investments in equities are preferable since short bursts of higher rates can never be sufficient to create a sizable corpus. FDs may appear to be a desirable and secure investment option in general, but adequate exposure to equities is required.

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Story first published: Friday, July 29, 2022, 16:16 [IST]

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