SBI FDs offer up to 6% returns in short term. Should investors explore debt mutual funds instead?

Time of India

4 days ago

With SBI, the largest public sector lender, reducing interest rate on certain short-term tenure fixed deposits by 15 basis points for three tenures, mutual fund experts mentions that followed by the recent repo rate cut by the central bank, many banks are cutting their FD interest rates, making traditional FDs less attractive and short term
debt mutual funds
such as liquid funds and overnight funds may give better post-tax returns.
'Liquid funds and overnight funds may well give better post-tax returns to especially those at higher tax brackets while offering similar liquidity. Those in the 20%+ tax bracket could opt for hybrid Arbitrage funds for better taxation. Please also note that interest on FDs is taxable even on an accrual basis, whereas in case of
mutual funds
it is only when redeemed,' Rajesh Minocha, a Certified Financial Planner (CFP), Founder of Financial Radiance shared with ETMutualFunds.
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Another expert recommends best suited funds for investors with an investment horizon of up to six months and for the ones with an investment horizon of more than six months.
'Investors looking for short-term parking options may consider alternatives like ultra-short duration funds for periods up to 6 months, as they offer potentially better post-tax returns. For investment horizons above 6 months, arbitrage funds can be a more efficient option. They carry similar risk profiles to debt funds but may deliver slightly better returns,' Hrishikesh Palve, Director at Anand Rathi Wealth Limited told ETMutualFunds.
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SBI has reduced the FD rates by 15 basis points for three short-term tenures. The bank has reduced the interest rate for the tenure of 46 days to 179 days from 5.05% to 4.90% for general citizens. The FD interest rate for tenure between 180 days and 210 days has been reduced from 5.80% to 5.65%. For the tenure of 211 days to less than 1 year, the bank has lowered the rate from 6.05% to 5.90% for general citizens.
These new interest rates are effective from July 15. In case of senior citizens, the FD rates have been reduced by 15 bps as well for the same tenures.
According to a report by ETWealth, After revision, the bank is offering FD interest rate between 3.05% and 6.45% (excluding Amrit Vrishti rates) for general citizens. The interest rate is applicable FD tenure ranging between 7 days and 10 years. For senior citizens, the bank offers FD interest rate between 3.55% and 7.05% (including SBI WeCare) for the same tenure.
FD vs debt funds
Coming to the comparison between fixed deposits and debt mutual funds, fixed deposits are considered low risk investments as they offer a guaranteed return for the predetermined period whereas debt mutual funds have a slightly higher risk associated with them because of the interest rate movement.
The second point of difference comes on the taxation part. The investment in tax-saving fixed deposits is exempted under Section 80 C of the Income Tax Act whereas for the debt mutual funds there is no such exemption. But both fixed deposits and debt mutual funds are classified under the same asset class.
As SBI slashed rates and experts recommended debt mutual funds as an option for short-term goals, investors are wondering that how does the tax efficiency of short-term debt funds compare to these FDs for someone in the higher tax bracket, to which Minocha replies that though the indexation benefit is removed from the debt funds, their taxation will still be better as they are taxed only when redeemed.
However, Palve is of the view that for someone in a higher tax bracket, investing in debt funds or FDs doesn't offer much difference in terms of tax efficiency, since gains from both are now taxed as per the individual's income tax slab.
However, investors in this category can consider alternatives like arbitrage funds, as these funds carry a similar level of risk to debt funds but have the potential to offer better post-tax returns due to favorable taxation, making them more tax-efficient options for short-term investments, he added.
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FD-beating debt mutual funds
ETMutualFunds considered the performance of debt mutual funds in the last one year and found that around 312 debt mutual funds have marked their presence in the market for around one year. Out of these 312 funds, 310 gave over 5.9% return. Around 17 funds gave double-digit returns in the last one year.
DSP Credit Risk Fund offered the highest return of around 22.9% in the last one year, followed by HSBC Credit Risk Fund which gave 21.4% return in the same period.
Aditya Birla SL Credit Risk Fund and Aditya Birla SL Medium Term Plan gave 16.9% and 13.9% returns respectively in the same period.
Three funds - DSP 10Y G-Sec Fund, Baroda BNP Paribas Corp Bond Fund, and Nippon India Dynamic Bond Fund - gave 10% each and were the last ones to offer double-digit returns. ITI Overnight Fund gave a return of 6% in the last one year.
Outliners
Samco Overnight Fund and Motilal Oswal Ultra Short Term Fund offered equivalent returns to the FD interest rate in the last one year. The schemes gave 5.9% each in the said time period.
Investors generally consider overnight and liquid funds as an option for parking idle savings outside the world of banking. For a savings account alternative, safety and liquidity must take priority over anything else and liquid funds and overnight funds come closest to satisfying these conditions.
While discussing mutual fund categories that can now be considered a superior alternative to short-term FDs, especially for emergency funds, both the experts recommend liquid funds and ultra short duration funds.
Liquid funds and ultra-short duration funds could indeed confer superior tax efficiencies, daily liquidity and no penalty if redeemed earlier, and marginally better returns than short-term fixed deposits and for those above 20% tax bracket could consider arbitrage funds, is what Minocha recommended.
Echoing similar opinion, Palve said for short-term goals and emergency funds, liquid funds & ultra-short duration funds can be a strong alternative to fixed deposits as they typically invest in debt and money market instruments with a duration of 3 to 6 months, offering better post-tax returns and higher liquidity and are especially suitable for investors in higher tax brackets, as they can deliver slightly better returns than FDs while maintaining a low-risk profile.
Latest data from Association of Mutual Funds in India (AMFI) shows that mutual fund investors have realigned their short-term investments, pulling money out of liquid and overnight funds amid changing preferences as these categories together have witnessed an outflow of more than Rs 81,000 crore in the last two months - May and June.
In the last two months, liquid funds have seen an outflow of Rs 16,274 crore and overnight funds saw an outflow of Rs 65,401 crore.On the contrary, money market funds have been receiving huge inflows. Based on the data, money market funds have received the second highest inflows in the last three months - April, May and June within 16-sub categories in debt mutual funds.
In May, corporate bond funds received the highest inflow of Rs 11,983 crore among 16-sub categories whereas in June, short duration funds received the highest inflow of Rs 10,276 crore.
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As corporate bond funds and short duration funds are also gaining investors' interest, can these be considered to park idle cash with liquidity and slightly better returns to which Minocha recommends that liquid funds, ultra-short funds, short-duration and arbitrage funds will give better post-tax returns with a reasonable degree of liquidity and fair safety, ideal for parking idle funds.
Whereas Palve says that with falling FD rates, investors can consider mutual funds as a better alternative to park idle cash but being selective is important.
'For an investment horizon of up to 1–6 months, ultra-short duration funds are suitable as they offer good liquidity and stable returns. For horizons above 6 months, arbitrage funds work well since they provide slightly better return potential than traditional debt funds, with comparable risk and better tax efficiency,' Palve said.
We considered all debt categories such as gilt fund, long duration, medium to long duration, gilt fund - constant maturity 10 year, credit risk funds, liquid funds, money market funds, overnight funds, corporate bond fund, dynamic bond fund, floating rate bond, banking and PSU funds, medium duration, low duration, short duration funds. We excluded debt based target maturity funds. We considered regular and growth options.
We calculated returns for one year. We calculated simple annualised returns as in debt mutual funds, returns up to one year are annualised and above one year are CAGR.
(
Disclaimer
: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
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