FD Vs Debt Funds: What Should NRIs Choose?

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Key Takeaways

For NRIs, fixed deposits and debt mutual funds are safe investment options in India. The investment vehicle they choose largely depends on the return on investment, the risk associated with the investment, the investment tenures and tax implications. Find out which is the better investment option for NRIs in this article.

Introduction

Mr. Singh is a Non-Resident Indian who has been living in the United States for 12 years now. Upon completing his MBA there, he found a work opportunity and has since been living there. He routinely sends money to his dependent parents back in India and sometimes invests money too. Currently, he is looking for a safe investment opportunity in India. He is conflicted about whether to invest in debt mutual funds or fixed deposits. Let us help him decide which will be the better option for him.

NRI Fixed Deposit Vs Debt Mutual Funds – Which Is Better?

For any investment comparison to truly make sense, it is always best to start with the definitions. Let us begin with fixed deposits.

Fixed Deposits

A fixed deposit is a type of investment wherein you have to deposit a specific amount for a fixed tenure. You typically earn interest on your deposit. A fixed deposit is primarily deemed as one of the safest investment vehicles. It is usually preferred by retired people living on a fixed income. The interest earned on FDs depends on the investment tenure, i.e. shorter the term, the lower the interest rate, and the longer the tenure, the higher the interest rate.

Debt Mutual Funds

A debt mutual fund is a mutual fund that primarily invests in fixed income securities, including government and corporate bonds, corporate debt securities, debentures, and other such money market instruments. These instruments enable investors to grow their capital and earn market-adjusted returns. The exposure to risk remains considerably low. Debt mutual funds are relatively stable investment options that help generate and grow wealth without significant risk exposure.

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Differences between NRI Fixed Deposit Vs Debt Mutual Funds

At face value, both fixed deposits and debt funds appear similar in that they offer fixed returns. As such, Mr. Singh needs to look beyond the superficial aspect of investing in these instruments. Let us dig deep, to help him make his final decision.

• Types

  The first point of difference between NRI fixed deposit vs debt mutual funds concerns the types. Fixed deposits are primarily of two types: cumulative and non-cumulative. If Mr. Singh opts for the former, he gets his primary investment amount along with the total interest payment when his FD matures. If he opts for the non-cumulative option, he will get a fixed sum as interest pay out on a monthly, quarterly, half-yearly or annual basis. As for debt mutual funds, Mr. Singh can choose from as many as 16 types of debt mutual funds classified by SEBI. These funds are classified by duration, type of investment, asset allocation and more. He may choose to invest in an overnight fund maturing in 1 day, a money market fund maturing in 1 year, a medium to long-duration fund maturing in 3-4 years, a gilt fund with 10-year constant duration more. In theory, the different types and tenures of debt funds make them a more dynamic choice for Mr. Singh to consider. But there is more.

• Investment Risk

  Now, a debt mutual fund is a market-linked instrument. Like with any market-linked instrument, there is always an element of risk associated with the investment. If the value of his mutual fund falls, Mr. Singh’s capital may be at risk too. On the other hand, if his mutual funds perform well, his earnings may be higher than what he would earn from his fixed deposits. If he is completely risk-averse, Mr. Singh should opt for fixed deposits, since they are not linked to the market. Furthermore, as per the Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the Reserve Bank of India, his fixed deposits up to INR 500,000 are insured in the event that his investing bank collapses. In this regard, the FD seems like a better investment option.

• Investment Tenures and interest Rates

  As an NRI, Mr. Singh can open an NRO or NRE fixed deposit. If he chooses the former, he gets the same interest rates as residents Indians. If, however, he opts for NRE fixed deposit, rates of interest and investment tenures may differ. Typically, an NRE FD comes with minimum investment tenure of 1 year and maximum investment tenure of 10 years. But since debt funds come with various ultra-short, short, medium, and long term tenures, he can simply choose funds with his preferred tenure. While he may not earn interest on his investment, he may book comparatively higher profits in a bullish market or endure losses if the market falls during his chosen investment tenure.

• Return on Investment

  As mentioned earlier, the returns Mr. Singh accrues on his fixed deposits are typically static or fixed. They depend on the interest rate at the investment time, and there is usually no risk associated with the capital. But FD interest rates have been declining steadily for years now. As such, even though an FD is a less risky investment, it may not amount to higher returns in the long run. In contrast, debt funds may not give Mr. Singh assured returns. While the returns on debt funds are market-linked, there is sufficient historical data that suggests that debt mutual funds usually outperform fixed deposits of similar tenures. As such, debt funds score over fixed deposits on his front.

• Liquidity

  If liquidity is a primary concern for Mr. Singh, then he should stick to debt mutual funds. While both are highly liquid investments, FDs attract penalties on premature withdrawals. If Mr. Singh chooses to withdraw his FD before maturity, he is liable to pay a penalty which could be a percentage of his capital investment amount. With debt mutual funds, he can consider his preferred tenure before investing. If he still decides to redeem his investment within the exit load period, he will have to pay an exit load on the redemption amount. Conversely, if he redeems the investment after the maturity period, he will not be liable to pay any additional charges. However, he should check the exit load structure of his preferred debt fund schemes before investing.

• Taxation

  The final difference between NRI fixed deposit vs debt mutual funds concerns taxation. Mr. Singh will have to pay a tax on the interest earned on his NRO FD, whereas if he opts for an NRE FD, the interest income earned is tax-free in India. If he opts for debt mutual funds, he will be liable to pay short-term capital gains per his income bracket. If he holds the funds for over three years, he needs to pay a 20% long-term capital gains tax with indexation benefits or 10% without indexation bracket. However, as a US resident, Mr. Singh will not be charged a tax on the same investment twice (i.e. in the USA) as he is protected under the Double Taxation Avoidance Agreement.

Final Note

For Mr. Singh and other NRIs like him, both NRI fixed deposit vs debt mutual funds are great investment options. However, the bottom line is that if he wishes to safeguard his investment completely, he should opt for FDs, but if he wants market-adjusted returns, the latter is the better investment option.

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*Disclaimer: This article is published purely from an information perspective and it should not be deduced that the offering is available from DBS Bank India Limited or in partnership with any of its channel partners.

The purpose of this blog is not to provide advice but to provide information. Sound professional advice should be taken before making any investment decisions. The bank will not be responsible for any tax loss/other loss suffered by a person acting on the above.