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Thursday 10 February 2022

Bank FDs score over Debt funds

Interest rates are all set to rise. Central banks across globe are facing pressure of high inflation. US have inflation of 7% which is at 40 years high and Europe on the hand has 5% inflation which is at 30 years high. As crude is near 90$ a barrel we also have to face the higher inflation. Federal Reserve signalled a rate hike in coming March. Government borrowings will go up after high capex is announced in the budget 2022.

Debt funds of mutual fund gave better returns till last 6-8 months but as the rates are likely to go up the debt will not give better returns. The duration play is over. 10 year gilt is trading above 0.80 paise than coupon rate. Long duration and medium term bonds may give negative or very low returns. Investors must know that the bond prices drops when rates go up.  

Now it’s time to evaluate the debt investment in the current scenario. Last one year’s returns of debt mutual fund investment has fallen below the fixed deposit rates. The average 1 year return of regular plans in liquid and money market fund is below 3.50%. The average 1 year return of low duration and short term fund is below 4%. The average 1 year return of corporate bond and gilt fund is below 4%  The charges are also high which reduces overall return. In MF debt funds net returns are gained after you minus expenses from YTM (Yield till maturity). The returns are also subject to credit and duration risk which most investors fail to understand.

On the other hand the fixed deposits rates are around 5/5.50% in bigger banks. Safe corporate deposits of AAA rated co. offers around 6/6.50% p.a. return. The senior citizens also get 0.25% or 0.50% higher in fixed deposits which are not available in debt fund investments. Recently government increased the limit of insurance for bank deposits from Rs. 2 lakhs to Rs. 5 lakhs also gives advantage to banks fixed deposits.

Mutual funds must relook high expense in debt products given current unfavourable conditions and make debt products more competitive. Debt funds are unlikely to beat fixed deposits rates going forward. The tax treatment is same both in FD and MF if you invest for less than 3 years time horizon.