Mukesh (Investor): Sujit, I’m planning to invest in a fixed deposit (FD), but I heard that the RBI has cut the repo rate. Does that mean FD rates will also go down?
Sujit (Financial Planner): Exactly, Mukesh. Think of it like this—when petrol prices drop, cab fares often follow the same. Similarly, when the RBI lowers the repo rate (the rate at which it lends to banks), banks also reduce the interest they offer on FDs. So, if you’re keen on FDs, locking in current rates before they drop further could be a good idea.
Mukesh: That makes sense. But before I jump in, what are some things I should keep in mind with FDs?
Sujit: Good question. FDs are like a fixed-rate train ticket—you know exactly what you’ll get at the end of the journey, but there are conditions:
- Breaking an FD early comes with penalties – Imagine booking a hotel for a week but checking out on Day 3; you’d likely lose some money. Similarly, banks charge a penalty (0.5-1%) if you withdraw early, plus you may get a lower interest rate based on your actual holding period.
- Tax impact – The interest you earn is added to your taxable income every year, just like your salary. If you’re in a higher tax bracket, your actual returns could be much lower than the advertised rate.
Mukesh: Got it. What are the current FD rates?
Sujit: Right now, major banks are offering around 6.5-7.5% for tenures of one to five years. Small finance banks may offer up to 9%, but they do come with slightly higher risk—kind of like choosing between a well-known airline and a budget carrier.
Mukesh: Hmm… Are there better alternatives?
Sujit: Yes! Debt funds, especially short-duration funds and targeted-maturity funds (TMFs), can be great options.
Mukesh: And how do they work?
Sujit: Think of a short-duration fund like a recurring deposit that invests in bonds maturing within 1-3 years. TMFs are more like a fixed deposit with not a set maturity date—you invest and hold, making returns more predictable.They are debt mutual funds that aim to replicate a specific debt index.
Mukesh: That sounds interesting. Have they performed better than FDs?
Sujit: Absolutely! If you compare their performance over the last five years:
- 1-year period: Debt funds outperformed FDs about 65 to 70% of the time.
- 2-year period: They outperformed ~75% of the time.
So, much like choosing between cooking at home (FDs) and ordering a meal kit (debt funds)—both get the job done, but one may offer more convenience and flexibility.
Mukesh: What about taxation?
Sujit: Debt funds have an edge here. Unlike FDs, where tax is deducted every year, debt funds are taxed only when you sell them. It’s like delaying tax payments until you actually withdraw money, allowing your investment to grow more efficiently.
Mukesh: That’s a big plus! And liquidity?
Sujit: Another advantage! With FDs, breaking them early costs you. But with debt funds, you can withdraw anytime without a penalty—like canceling a flight with a refundable ticket.
Mukesh: Are there any risks?
Sujit: Yes, but they can be managed:
- Interest rate risk – When interest rates rise, bond prices fall, slightly impacting returns. But short-duration funds handle this better than long-term ones.
- Credit risk – Some funds invest in lower-rated bonds (kind of like lending money to a friend with an uncertain repayment history). Sticking to AAA or AA-rated funds keeps the risk lower.
Mukesh: So, what’s your final advice?
Sujit: If you’re looking for 100% safety and fixed returns, go ahead and lock in a long-term FD before rates drop. But if you want higher potential returns, flexibility, and tax efficiency, debt funds—especially short-duration funds and TMFs—are a smarter choice.
Mukesh: I like the idea of having both—some in FDs for security and some in debt funds for better returns.
Sujit: That’s the best approach! Just like balancing your meals—you need both home-cooked food and a few restaurant outings.
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