Investment is all about sound decision making. Should you invest in FDs or mutual funds? This is a problem you face. You must always invest based on risk profile. Sounds a difficult word? Risk profile is nothing but the ability and the willingness to bear risk.
If you are an aggressive investor, consider an investment in equity, mainly equity mutual funds and shares. Equity gives high returns, but at high risk. If you’re the conservative type, consider investing in fixed income securities. Fixed income securities invest primarily in debt and offer fixed periodic payments like regular interest payments. The principal is returned at maturity.
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Fixed Deposits or FDs are an investment offered by banks and even NBFCs, where you deposit money and earn higher interest than savings bank accounts. You are not supposed to withdraw before maturity, but can do so after paying a penalty.
Investment is safe with no risk on the Principal. Returns are fixed and you can opt for periodic interest payouts to manage monthly expenses. You earn decent interest with banks hiking FD rates as RBI hikes the repo rate. The RBI has opted for back to back repo rate hikes in the last two policy review meets. The repo has moved from 6% to 6.5%, with another 25 bps hike, on the cards.
Interest earned on FDs is taxable. The interest you earn is added to taxable salary and you are taxed as per tax bracket. If your income is below the minimum tax slab of 5%, you can claim a refund on TDS deducted by banks. You can avoid TDS by submitting Form 15G (Form 15H in case of senior citizens) and then your bank will not deduct TDS. If you fall in the higher tax bracket (20% or even the 30% tax bracket), you have to pay tax over and above the TDS already deducted.
You can also invest in a 5 year tax-saver FD and enjoy Section 80C benefits up to Rs 1.5 Lakhs a year. You can’t touch this investment for 5 years and interest is lower than a normal FD.
How is interest calculated on FDs?
A = P (1+r/100/4) ^ (4*n)
A = Amount at maturity.
P = Principal
n = tenure of the deposit
r = rate of interest
Let’s understand how FD interest is calculated with a simple example. You have deposited INR 1 Lakh with a reputed bank. You are paid an interest of 7% compounded quarterly. Your fixed deposit matures in 5 years.
A= 100000 * (1+ (7/100/4)) ^ (4*5)
A = 100000*1.4147 = Rs 1,41,470.
Interest earned is Rs 141470 – Rs 100000 = Rs 41,470.
A mutual fund is an investment vehicle that pools your money along with that of several investors and invests in bonds, stocks, short-term money market instruments and commodities, depending on the type of mutual fund. The mutual fund is managed by professional fund managers and they charge a fee for it.
An equity mutual fund invests most of the money in stocks; while equity diversified mutual funds and ELSS invest in stocks across sectors. Debt funds invest most of the money in bonds and balanced funds invest in a mix of stocks and bonds. Liquid funds and Liquid plus funds invest most of the money in money market instruments like certificates of deposits, commercial paper, treasury bills and reverse repo among others.
People in India love investing in FDs and RDs as the principal is safe and interest is earned on the investment. But, for a really long time, people of India didn’t like investing in mutual funds. Mutual funds were not considered a safe investment.
Mutual funds are all about high returns at high risk. When you talk of high risk, it means equity mutual funds. If you stay invested in equity funds for the long term, say 5-7 years, then even equity mutual funds are safe and you enjoy good returns on investment.
Mutual funds are not all about equity mutual funds. There are debt funds which offer a measure of capital protection and even guaranteed returns. Balanced funds have a sizeable debt component, and even though equity balanced funds have at least 65% invested in equity, the 35% debt provides a cushion when stock markets crash.
Your investment in mutual funds is safe because:
Remember: No investment is free of risk. Even FDs have risk. Inflation the rise in prices of goods and services with time, eats up returns from FDs. CPI Inflation was 3.69% for August 2018. While no investment is 100% safe, always opt to stay invested in mutual funds for the long term. This cuts down the risk in investment.
Dividend option in mutual funds: Mutual funds offer the growth option and the dividend option. In the growth option, the mutual fund invests in high growth Companies. Money gets reinvested as Companies grow and expand. This increases the NAV of the mutual fund. If you are an aggressive investor focusing on high returns, invest in mutual funds growth option.
In the dividend option, money is not reinvested but paid out to investors in the form of dividends. A mutual fund which invests in dividend stocks passes these earnings to shareholders in the form of dividends. Mutual funds with the dividend option reward long-term investors with cash dividends. If you want regular income (say a retired person who needs regular income in retirement), then invest in mutual funds dividend option.
Expense Ratio: A mutual fund incurs various expenses like fund management fees, marketing and selling expenses, costs of investor communication, custodian and registrar fees. The sum total of all expenses in a mutual fund is the total expense ratio, popularly called TER. It’s the total cost you have to bear when investing in a mutual fund.
SEBI has asked all mutual funds to disclose TER on a daily basis, so that investors can make real time decisions when investing their money. Find this difficult to understand:
Let’s say you have invested in a mutual fund which has given 10% returns. The actual returns generated by the fund house would be 12%. The total expense ratio (TER) is 2% and this has eaten up a percentage of your returns. The upper limit for a fund house to charge TER is 2.5% for equity schemes and 2.25% for debt schemes.
What is liquidity of an investment? Liquidity is nothing but how quickly an investment can be converted to cash. Liquid mutual funds and liquid plus mutual fund schemes, which invest in money market instruments, enjoy high liquidity. SEBI has allowed instant redemption up to Rs 50,000 or 90% of folio, whichever is lower.
If you stay invested in an equity fund for under a year, short term capital gains (STCG) are taxed at 15% + cess. If you stay invested for more than a year in equity, capital gains are called LTCG and you pay a 10% tax on long-term capital gains above Rs 1 Lakh a year.
If you stay invested in a debt funds for under 3 years, gains are STCG. These gains are added to taxable salary and taxed as per tax bracket. If you stay invested for 3 years or more, gains are called LTCG. LTCG is taxed at a flat rate of 20% with indexation benefits.
Equity linked saving schemes popularly called ELSS, invests most of your money in equity. ELSS has a lock-in period of 3 years. Investment in ELSS enjoys Section 80C benefits up to Rs 1.5 Lakhs a year.
Do not stick to the minimum investment of Rs 1.5 Lakhs a year which qualifies for the Section 80C benefit. Invest more than the minimum investment, for at least 5-7 years, (long term investment) to earn great returns from ELSS.
Systematic Investment Plans popularly called SIPs is not a mutual fund, but just a method of investing in mutual funds. You invest small amounts at regular intervals say daily, weekly or monthly in mutual fund schemes.
Investors got greedy and pumped money heavily in multi-cap funds in calendar year 2017. Multi-cap funds gave more than 30% returns for calendar year 2017. Mid-caps gave more than 40% returns for calendar year 2017.
Now, Multi-cap funds have lost more than 8% in just a month and Mid-caps have lost more than 11% in the same time. Investors are running back to their beloved FDs. If you can’t bear risk in investment, stick to FDs. Equity is for aggressive investors who can bear high risk for high return.
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