Mutual funds are the most buzzing investment option in recent times. Majority of millennials prefer mutual funds to achieve their financial goals as they get better returns and higher degrees of flexibility as compared to most other investment options. Some people go with bank fixed deposits, and they give up on a host of benefits that they would get on choosing mutual funds.
Here are 5 reasons why mutual funds are better than bank FDs:
1) Potential to earn much higher returns
Bank FDs provide assured returns at a fixed rate over a defined period of time. The interest offered by FDs will always be restricted and can never beat inflation. To make it worse, the falling interest rates over the last one and a half year has brought down the interest offered on FDs to fall in the range of 4% to 7%.
On the other hand, mutual funds have the potential to beat the benchmark and inflation. The diversified portfolio of mutual funds helps investors earn much higher returns than a fixed deposit.
Bank fixed deposits come with a predefined investment tenure. To make a penalty-free withdrawal, you have to let your investment complete this tenure. Premature withdrawals attract a penalty in the form of reduced interest. Lower interest rates coupled with penalties on premature withdrawals has made fixed deposits an unattractive investment option.
Most mutual funds are open-ended. Meaning, you can invest and redeem your investment at any time. This is of utmost importance if you are looking to park your surplus funds and earn higher returns. For short-term investment, you may consider investing in overnight, liquid and ultra short-term funds.
3) Tax efficiency
Bank fixed deposits are not tax-efficient. The returns provided by FDs are added to your overall income and taxed at your income tax slab rate. In particular, this is of a great disadvantage if you fall in the highest tax bracket. This is where equity mutual funds score better.
Most of the gains you make through mutual fund investments are in the form of capital gains. The short-term capital gains, realised on selling your equity fund units within a holding period of one year, are taxed at the rate of 15% irrespective of your income tax slab rate. Long-term capital gains of up to Rs 1 lakh a year are made tax-exempt. Any gains over and above this limit are taxed at 10%.
Short-term capital gains, earned on redeeming units of a debt fund within a holding period of three years, are added to your overall income and taxed at your income tax slab rate. Long-term capital gains, realised when you redeem your units after a holding period of three years, are taxed at 20% after indexation. Dividends offered by all mutual funds are added to your overall income and taxed at the income tax slab rate you fall under.
4) Switch option
If you have found a better performing mutual fund scheme whose objectives and risk levels are matching your requirements, then you may consider switching funds. As most mutual funds are open-ended, you will not have to bear any significant charges on switching funds.
On the other hand, fixed deposits levy hefty penalties on investors for making premature withdrawals. Also, fixed deposits offered by all banks provide returns in the same range, that is between 4% and 7%. Therefore, ‘switching’ fixed deposits is not a great option.
Investing in mutual funds comes with a host of benefits. Fixed deposits are not a great investment option as they offer a restricted rate of return. Mutual funds are the best investment option to achieve your financial goals.
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Engineer by qualification, financial writer by choice. I am always open to learning new things.