Why You must shift from Bank Deposits to Mutual Funds

Highlights

  • A Measly 2.5 - 3.5% on savings bank deposits and 5-7% on other deposits are going to be the normal from now.

  • Mutual funds not only give higher returns than the banking products but are also liable for a lower tax outgo.

  • The types of mutual funds that work well as substitutes for bank accounts are liquid funds and ultra-short duration funds.

The benefits of using funds instead of fixed deposits go much beyond a simple comparison of returns. The different taxation structure means there’s a bigger difference in post-tax returns. The tax difference arises from the fact that returns from fixed deposits are classified as interest income while mutual fund returns are classified as capital gains. 

Under interest income, you have to pay tax every year for the what you have earned that year. If your total interest income from a bank (all accounts and deposits together) exceed Rs 10,000, then the bank also deducts TDS at 10%. In fact, if the bank does not know your PAN, it will deduct 20%. This means that a part of your return is not available for compounding because it is taken out and paid as tax every year. 

There is a further advantage to the mutual fund option if you stay invested for more than three years. If you redeem after three years, then the gains are classified as long-term capital gains and are taxed after indexation. Essentially, you get taxed only on inflation adjusted returns. Again, this does not happen with FDs. Applying all these factors, a three year investment in a short-term fund will leave you with almost twice the returns as an FD over the same period, and with excellent liquidity . 
 

with low interest rates, the payoff is huge, and a lot of us could benefit substantially from shifting away from deposit-type products and towards mutual funds. 
 

Source: ET CONTRIBUTORS

 

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