Demystifying debt or fixed-income products is as complex as selecting the Indian World Cup squad. Everyone has a view depending on one's street address. Add to that the complexities of macro-economic environment, which are as vague as the frequent injuries to Indian cricketers. This debate is as old as the existence of fixed-income funds. Fixed income as a category, whether one invests in fixed deposits (FDs), debt mutual funds (MFs) or corporate deposits/bonds (CDBs), is supposed to provide investors a fixed income.
To address the moot point of FD versus mutual funds (MFs), FDs offer fixed rates, which are determined the day one enters into a deposit contract with the bank.
But that is not the case with MFs. They are variable return products, returns on which vary with the movement of interest rates. As for fixed-income funds, variations can be very small compared to equity funds. However, the customers should analyse these variations alongwith their financial planners before entering these products. That said, mutual funds have several advantages over deposits that give them an edge over FDs – liquidity, no pre-payment penalty and a tax advantage.
For example, considering today's scenario, if one were to invest for one year (short-term debt MFs), the table above will be give you a rough comparison for the investor who falls in the highest tax bracket. It clearly shows that net of taxation, a short-term debt fund outperforms the FDs. However, neither of these instruments can outperform rising inflation, which is a cause of concern.
2011 has begun with high interest rates and high inflation. This scenario is a continuation of the second half of 2010. This may not change for the forseeable part of 2011 as fuel prices continue to rise and as structural supply-side constraint persist. In this case, since the Reserve Bank of India's (RBI) primary objective will be to control inflation, further rise in interest rates is not ruled out.
It is highly recommended that investors park their money in short-term debt funds till they find interest rates almost peaking out (March-September 2011) and then lock their investments in bank fixed deposits and longterm income funds/FMPs. Typically, March-end (end of financial year) presents good opportunities for entering into long-term products.
