Looking for a better option than an FD? Try passive debt funds!

It is said that comparison is the thief of joy. While this may be apt for other aspects of life, it is not always true when it comes to investing your hard-earned money. Comparing different options while investing helps you make well-informed decisions that eventually reflect in your returns. On that note, have you ever compared fixed deposits (FD) with other similar types of investments? Did you ever think that a passive debt fund could be a better option than an FD? Passive debt funds are not very commonly known. Nevertheless, they can be a good alternative to FDs. Let’s know more.

Brush up your FD knowledge

An FD is a fixed-income financial instrument offered by banks, post-offices, and non-banking financial companies. It allows you to invest lumpsum money for a fixed period to earn fixed returns. The period usually ranges from 7 days to 20 years.

You must have heard your elders say that FDs are safe. This is almost true because they offer fixed and guaranteed returns. But remember, they lock your money for a fixed tenure. So, you lose out on liquidity. You may be allowed to withdraw your money prematurely but that may be subject to penalties.

Now that you know about FDs, let’s move on to understanding passive debt funds.

What are passive debt funds?

Passive literally means accepting or allowing whatever is happening instead of acting or responding actively. Thus, passive debt funds do not buy and sell securities actively. Instead, they just track and mimic the performance of a particular debt benchmark. They aim to generate identical returns instead of trying to beat the market. Thus, the fund manager has a limited role to play in the case of passive funds. Passive debt funds are said to be relatively low-cost mutual funds in India as compared to active debt funds.

A target maturity fund is an example of a passive debt fund. It is an open-ended passive debt fund that has a pre-defined maturity. Because a target maturity fund only invests in a portfolio of bonds which mature on or before a fixed maturity date, you can know the indicative yield at the time of your investment , thanks to the Yield to Maturity (YTM) formula. So, if you stay invested in the fund till the end, you can be reasonably certain of how much you will be getting on your investments.

With a fixed tenure and a certain yield, target maturity funds can be similar to FDs in terms of the investment experience that they offer. But what makes them better? Let’s find out.

Target maturity fund vs fixed deposit

A target maturity fund is a better option than an FD because of two main reasons.

1. Liquidity: When you put your money in an FD, it gets locked for a specific period. You may not be able to use the money before maturity. However, a target maturity fund is an open-ended debt fund, so you can sell your investments anytime and get the proceeds in your bank account. Though, it is advisable to stay invested in the fund till maturity if you want to get returns closer to the YTM.
2. Tax efficiency: The accrued interest on FDs is taxed as per your income slab, irrespective of your FD tenure. But target maturity funds are taxed differently for short-term gains and long-term gains. Short-term capital gains on target maturity funds are taxed just like FD returns, that is, as per your income slab. But long-term capital gains on these funds are taxed at 20% with indexation benefits. So, not only they can be more tax-efficient than FDs if you fall in the tax brackets higher than 20% but also your cost of investment is raised to the applicable indexation factor thereby reducing your taxable gains. This is because you will still be paying taxes on your gains at 20%.

To sum it up

Passive debt funds and fixed deposits both are low-risk options that can help you meet your financial goals. However, the former offers more liquidity and can turn out to be more tax-efficient in certain cases.

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