A lot has been spoken regarding the investment in Money Market / Ultra Short Debt Mutual Funds in the past. These mutual funds were suggested in place of fixed deposits because they can be liquidated any time and they don’t have any lock in period. Majority of the money market funds don’t have exit load feature which is provided is most of the fixed deposits schemes. The striking difference between both these investments was the tax aspect. The fixed deposits are taxable as per the income slab irrespective of their maturity period unlikethe case of Money Market/Ultra Short Debt mutual funds where if the investments were liquidated after 12 months, the gains would be termed as long term capital gain (LTCG) and the taxation was 10% without indexation benefit or 20% with indexation benefit whichever is lower. The returns generated from these funds in current market situation are also impressive and gain significant attraction of investors.
During the budget, the decision made by the Finance Minister regarding the change in holding period (3 years) and the tax rate (20%) has raised many a doubt on investor’s mind who had parked their money in Money Market/UltraShort Debt Funds. This decision may induce the investor to shift back to the traditional fixed deposits schemes.
Here we discuss how investing in these funds would still be a better option despite the recent changes.
To compare the benefits of these two investment options, we conducted simulation taking common amount of Rs 2 lacs, rate of returns as 9% for the tenure of 3 years. The tax slab considered was 30% and the exit load in case of fixed deposits was taken at 1%. We also assumed the impact if these funds are liquidated before the tenure as the case of premature liquidation should also be considered.
The post tax gains by investing in MM/UST mutual funds after 3 years were Rs 5900 higher than the fixed deposits (7.32% as compared to 6.46%). In case the investment is withdrawn in the beginning of second year the returns in fixed deposits are reduced by 1% as exit load which makes the gains in MM funds higher. (6.30% as compared to 5.6%).
Please refer to the table below for calculations
|Fixed Deposits||Money Market Funds|
|Gains after 3 years||Rs 41304||Rs 47204|
|Returns ( Post Tax)||6.46%||7.32%|
|Gains if withdrawal in 2nd year||Rs 11200||Rs 12600|
As Financial advisors we always recommend to invest your excess cash balance in a money market /ultra short term debt funds as an emergency fund. Despite the recent changes these funds are still a better option to invest as their post-tax returns would be better than the fixed deposits. The investor should understand that changes have come only in the tax treatment of the fund and not in their functioning. Also, we expect that the fixed income funds would perform better than the FD returns.