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Mutual Funds edge out Fixed Deposits

Arindam Ghosh

Every individual faces the dilemma of how to make their hard earned money grow. Historically, India has been one of the high saving nations in the world with as over 35 per cent of income is kept idling in savings accounts or time deposits.

As per the latest Max New York Life Insurance- NCAER India Financial Protection Survey, 2007, the total household savings stood at $190 billion out of which close to $100 billion is parked in banks (time deposits and savings accounts) and earns an interest rate between three per cent and nine per cent. This is not surprising considering that out of the 32.1 crore paid workforce in India, over 20 crore people still rest their faith in traditional investments like fixed deposits, postal deposits, government bonds, national savings certificates, chit funds, etc.

However, is investing in traditional instruments really the right thing to do? There are a host of disadvantages when it comes to investing in fixed deposits, The interest earned on a fixed deposit is not tax free; since the interest gets added to the individual’s income for the given year and is taxed according to the tax bracket that the depositor falls into.

For those falling in the top tax bracket, the interest earned from a fixed deposit is taxed at the rate of 33.99 per cent. Redeeming a fixed deposit before its maturity date is again unrewarding. Premature withdrawal of a fixed deposit has a cost attached to it. Most banks, in such cases, deduct an interest of 0.5 per cent for early withdrawal.

Due to urgent need of money, the depositor has to break the deposit at the end of one year, the bank will pay an interest of 8.5 per cent corresponding to deposit rates for one year. In this case, the individual will be paid an interest of 0.5 per cent less than 8.5 per cent which is eight per cent.

Today, investors realise the importance of making their money grow in a prudent manner. Many have embarked onto smarter and tax efficient investments like mutual funds which are an attractive means to invest your savings. When you invest in a mutual fund, your money is pooled along with the money of other investors and is used to buy securities like stocks, bonds, and other financial instruments. These are run by investment professionals who decide with expertise in managing investments and are governed by the Securities Exchange Board of India which is one of the most stringent authorities in India.

Today, over 5.3 million investors in India invest in different types of mutual funds given their distinct advantages one of which is that they are more tax efficient. Private sector mutual funds have been around for more than 15 years now and in some countries like the United States, mutual fund investments are in fact bigger than bank deposits.

To give you a better insight to the tax benefit, let’s assume an individual wants to invest Rs 10,000 for five years at a compounded interest rate of nine per cent in a fixed deposit as compared to the same investment terms in a equity oriented scheme of a mutual fund.

Investing Rs 1 lakh in a mutual fund helps the individual make additional returns of Rs 1,830.78 compared to the fixed deposits of banks.

Assumed rate

Even if one were to look at investing for period less than one year say nine months, returns from a mutual fund are taxed at 15 per cent (short term capital gains tax) which is much lower to the 33.99 per cent (considering highest tax bracket) that one may have to pay for a similar investment in a fixed deposit of a bank.

While mutual funds score on the tax efficiency front, another factor for one to invest in such instruments is inflation.

We all know that inflation affects our standard of living and our ability to purchase goods. Inflation in its true sense results in decline in purchasing power of money.

Today inflation is hovering at 12.44 per cent which means that the value of Rs 100 note has depreciated to Rs 87.66. Given this scenario one must look at an investment which gives you a return of at least 12.5 per cent so that the post-inflation returns are positive. Sadly, bank fixed deposits offer a return of only nine per cent or 10 per cent which is much lower than inflation.

If one were to add the tax liability to fixed deposit returns it would fall below eight per cent. Given the distinct advantages that mutual funds offer over Fixed deposits, they are sure to command a significant portion of the investment wallet in the times to come!

Arindam Ghosh is the chief executive officer of Mirae Asset Global Investment Management (India) Ltd.