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Debt Funds vs Bank Fixed Deposits

The returns under debt funds are not assured

I wish to invest my surplus money in mutual funds to generate better returns than bank fixed deposits (FDs). My surplus money is invested in the weekly dividend option of HDFC Cash Management Treasury Advantage Fund as its dividend income is tax free. But this fund’s returns have fallen in recent times. Please suggest a good option that will optimise returns.
 -Setu Shah

All debt fund dividends are tax free in the hands of investors, but they are subject to dividend distribution tax (DDT), which is borne by investors only. For the purpose of DDT, debt funds are classified in two categories -- cash funds (liquid funds and short-term floating rate funds) and other debt funds (including liquid plus funds). While the rate of DDT applicable on the former is 28.33%, the latter is subject to 14.16% DDT.

In contrast, interest income from bank FDs is taxed as per the individual’s tax slab. Here, if the tax slab applicable for an individual is 20 per cent or more, the dividend option under the second category of debt funds with 14.16 per cent DDT is a more tax efficient option.

But unlike bank FDs, the returns under debt funds are not assured. Their performance is dependent upon the interest rate movements. Liquid plus funds offer higher returns, but are riskier than cash funds.

Of late, the returns of the liquid plus funds have dropped because of investors shifting to them from cash funds. With new money flowing in, the prices of bonds have fallen, causing returns of liquid plus funds to come down.

Moreover, in the near future, the returns of income funds are unlikely to be as attractive as in the past. They should not be expected to deliver better than bank FDs. However, their tax efficiency will continue to be a reason for their preference.

You can also look for dynamic bond funds that have flexible portfolio maturities, and can generate better returns depending upon the market conditions. But they will be more risky at the same time. Birla Sun Life Dynamic Bond and Kotak Flexi Debt are good picks.

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