Mutual Funds have become unparalleled choice of investment mode for long-term goals, yet there are many investors, who prefer to offload their surpluses in traditional vehicles such as bank fixed deposits to accomplish their short-term goals.
Long-term horizon provides mutual fund investors with comfort to bet on risks, but ‘market-linked’ performance scare most of them away from this investment route. However, this is not true always as there are an array of mutual funds that are designed to take care of short term goals. Broadly, liquid funds and debt funds qualify to be suitable for short-term investment needs.
Let’s take this case of Mr. Narayan Hari, who plans to buy a car in the next two years. He currently has a lump sum of Rs 3 lakhs and wishes to set aside Rs 10,000 every month towards this goal.
Options That Are Available to Mr. Hari
In the given scenario, Mr. Hari has two options, i.e., one to put his money in a fixed deposit or invest in a debt-based mutual fund that can meet his objective. Let’s evaluate how each of these options work for him.
- 1 Return Comparison
*Recurring deposit rates taken from http://www.sbi.co.in
The above table shows that Mr Hari’s gains would be better in debt mutual fund when compared to recurring deposit.
- Capital Safety – Recurring deposits are considered extremely safe, while debt funds are vulnerable to interest rate movement to an extent.This implies that debt mutual fund performance is largely dependent on the interest rate cut by the Reserve Bank of India. For instance, the recent interest rate cuts have positively influenced funds holding long-term bonds. On the other hand, performance of debt funds comprising portfolio of short-term bonds with maturity of one to two years are not closely linked to interest rate movement. Rather the returns are guided by the actual interest accrued by short-term bonds. This means that capital might be exposed to limited risk but will be rewarded through better returns as opposed to deposits.
- Tax Efficiency – The next objective of any investment is to earn higher tax efficiency, where deposits are largely a laggard against debt funds. Returns on deposits and debt mutual funds, when held for less than three years are taxed as per individual slab rate. Lower returns on deposits give debt mutual funds tax advantage over the former. Let’s take a look at how taxes impact returns between deposits and debt mutual fund.
- Flexibility – Debt mutual funds are way flexible than deposits when it comes to increasing the investment amount or withdrawing the invested sum before the pre-decided period. Sale of units can be made in debt mutual funds instantly, where the sum is credited within 3-4 working days. Unlike deposits, where pre-mature withdrawal is released at a lower rate alongside penalty charges, redemption’s under debt funds are not penalized. However, exit load in between 0.25% to 0.50% are applicable on units that are sold before stipulated time, which is usually six months to one year.
Apart from this, the amount of investment can be increased anytime in a debt fund, whereas only few banks are providing such flexible options to deposit holders.
- Yearly Tax Computation – Debt mutual funds also score over deposits as far as the extent of paperwork is involved. A deposit holder is supposed to calculate tax on interest income each year so as to declare and pay it during the return filing. Moreover, things can get bit twisted if there is a case of pre-mature withdrawal, where taxes are already paid as per the deposit rate but the withdrawal is allowed at a lower rate.
Conversely, gains from debt mutual funds are covered under capital gains tax that becomes applicable only when units are sold. Hence a debt fund investor need not to carry out yearly tax computation on his/her debt investments. To further simplify the process, mutual fund houses also provide capital gain statement to investors on request.
In A Nutshell
It becomes clear now that mutual funds are not only meant for long-term pursuits, but are equally efficient in servicing short-term objectives. Therefore, an individual much choose a mutual fund scheme that is in line with the tenure and objective to accomplish his/her goal while earning better returns than traditional products.
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