Two debt mutual funds deliver over 7% return in one year. Should you break your bank FD?

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Two debt mutual fund categories – liquid and money market funds – have managed to beat a year fixed deposit rate of 6.8%.

Liquid funds have risen 7.13% in the last one year while money market funds have delivered 7.15% returns during the same time.

Around 34 liquid funds have completed one year of existence in the market. Bank of India Liquid Fund gave the highest return of 7.31% in the last one year, followed by Axis Liquid Fund which gave 7.27% in the same period. Motilal Oswal Liquid Fund offered the lowest return of around 6.79% in the last one year.

Around 22 money market funds have completed one year in the market. Aditya Birla Sun Life Money Manager Fund gave 7.55% in the said period. Union Money Market Fund offered the lowest return of around 6.34% in the last one year period.

Interest rates

How did these funds manage to offer this performance? Did the rate pause by the RBI made these funds deliver this performance?“Money market and liquid funds invest in short-term investment products. The interest rate hikes that happened a couple of years back helped in eventually increasing the yields in these products, just like how fixed deposit rates have increased. While the interest rate hikes have stopped, there is also a pause that has determined the existing yields to remain stagnant and deliver this performance,” said Rajesh Minocha, a Certified Financial Planner (CFP), Founder of Financial Radiance.

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Taxation structure

Post the amendments made in Finance Bill 2023, debt mutual funds are now taxed as per the individual income tax slab rate. Fixed deposit is also taxed as per the individual tax slab rate but each time a FD is matured and is renewed, TDS is deducted. However, in case of debt mutual funds, there is no TDS deducted, the tax is paid when an investor redeems the units.

“Debt mutual funds scored higher than fixed deposits as they offered an indexation benefit and were taxed at a rate of 20% if they were held for more than three years. This was especially useful for those in the higher tax slabs. This benefit was removed in April last year and returns are now taxed based on taxable slab irrespective of holding years,” said Minocha.

“Still, they offer significant benefits as compared to fixed deposits. Unlike an FD, there is no pre-payment penalty and investors can withdraw whenever the money is needed and it gets credited the next business day. It is very useful, especially when emergency funds need to be established or money is planned to move periodically into equities,” he adds.

Liquid funds are benchmarked against CRISIL Liquid Debt Index and Crisil 1 Yr T-Bill Index which gave 7.30% and 7.12% returns respectively in the last one year.

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According to ACE MF, money market funds are benchmarked against Crisil 1 Yr T-Bill Index and CRISIL Composite Bond Index which gave 7.12% and 6.69% returns, respectively in the last one year.

Are you wondering if you should invest in debt mutual funds going forward?

“The outlook for debt funds is likely to remain steady in FY 25, till the time there is no change in interest rates. However, whenever investing, the investors should always consider these three risks in debt funds – inflation risk, interest rate risk and the credit risk,” recommends Minocha.

As per Sebi norms, liquid funds invest in debt and money market securities with maturity of upto 91 days only. Money market funds, according to Sebi, invest in money market instruments having maturity upto one year.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)

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