Fixed Deposits have been the favourite investment instrument of most Indians. Investors may think that as they have Fixed Deposits in their portfolio, they may not need to invest in Debt Funds as well. However, there are some points that every investor needs to consider since Debt Funds can be a better option than regular Fixed Deposit investments.

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Key pointers are highlighted below:

1. Reinvestment risk:

Around 20 years back, Fixed Deposits were returning approximately 10% p.a. But today fixed deposit rates have come down to merely around 5% p.a. Most Fixed Deposit investors invest for 3 to 5 years and renew their investments when these mature. So, when investors renew Fixed Deposits, they tend to reinvest at a lower interest rate. Also, the current interest rates applicable on Fixed Deposits are lower than the current inflation rate, which means the real rate on these instruments will be negative.

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2. Liquidity Problem

If an emergency arises and there is a need to withdraw money from a fixed deposit, then the bank charges a penalty for it. But there is no penalty for exiting debt mutual funds.

3. Taxation Benefit

With Fixed Deposits, investors have to pay tax on interest income as per their income tax slab. So, an investor who falls in the 30% tax slab, will have to pay 30% tax on the interest income earned from a Fixed Deposit. But in the case of Debt Funds, if investors redeem within 3 years, they will have to pay as per the income tax slab; those who redeem beyond 3 years will have to pay 20% along with the benefit of indexation.

How different categories of Debt Funds can be allocated for different financial needs

As there are several categories of Debt Funds, it is important that investor should know how they can allocate these debt funds for different purposes, as per their risk-taking ability.

1. Emergency: An emergency can arise at any point of time. So, investors should invest in those debt funds which are least risky and are subject to minimum volatility. While investing in these funds, returns should not be the primary goal of the investor. Overnight Funds, Liquid Funds and ultra short-term funds can be considered as investments for emergencies.

2. Long Term: While investing for the long term, investors should choose those funds that will not only bring stability to their portfolio but will also deliver more returns than fixed deposits, if possible. Investors can invest in Short Term Funds, Corporate Bond Funds and Banking & PSU Funds.

3. Tactical: These funds should only be included in a portfolio when an investor sees any opportunity for growth. For instance, if an investor feels that going ahead there will be a rate cut, then Gilt funds can be included in the portfolio. Other funds which can be used for tactical purposes are Medium Duration Funds, Long Duration Funds and Credit Risk Funds.