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Rehaan has decided to invest in a pool of debt funds. He has looked at the past performance of debt funds and shortlisted the same starting from the best performing fund. After reading the risk disclaimer Past performance of the Sponsors, AMC/Fund does not indicate the future performance of the Schemes of the Fund”, he is unsure whether it’s worth taking market risk for additional 1-2% returns.

Is it worth the risk? I could reduce the complication in life by investing in FD instead of worrying about Debt funds for an extra 1-2% return.

Irrespective of the financial goal, whether long term or short term, the allocation towards Debt is mandatory. Even if the goal is 20 year from now, there must be some allocation given to debt.  Basic thumb rule for Asset Allocation says 100 minus Age, so every individual must have exposure to debt. In cases of medium term and long term financial goals, the debt allocation could be done towards debt funds rather than fixed deposits.  

Historically, debt funds have outperformed the returns generated by Fixed Deposits consistently. This gives debt funds an edge over fixed deposits in the long run.  

Before comparing the performance of Debt funds vs Fixed Deposits, the most important aspect to be looked at is tax implication. Both Debt Funds and Fixed Deposits are taxed differently. Interest income is taxed as Income from other sources and added to the total income. At the same time, Debt funds are taxed under the Capital gains and the long term capital gains tax is 20% with indexation.

How much difference 1-2% can make in the long run?

Illustration:

The above mentioned illustration is a one-time investment. If the return difference between FD and Debt funds is 2%, the difference in the accumulation amount is close to 45% (Rs. 28.02 lakhs – Rs. 19.35 Lakhs). If the return difference is 1%, then the total accumulation would be 20% lesser in fixed deposits when compared to debt funds.

When the Recurring Deposits are compared with SIP in Debt funds the difference in the final accumulation amount is again substantial. If the return difference is 2% p.a then the final redemption amount would differ by 28% and by 14% if the return differential between Debt fund SIP and RD is 1%.

So it’s certainly worth a risk to give allocation to debt funds. In the long run, debt funds are “Tax efficient” and the fund manager would add value by “active portfolio management and diversification”.

The FD return are fixed wherein the returns generated from debt funds are market linked returns

The above table is for illustration purpose only & shall not be construed as indicative yields/returns of any of the Schemes of Canara Robeco Mutual Fund. Past performance may or may not be sustained in the future.

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Mutual fund investments are subject to market risks, read all scheme related documents carefully.