Fixed Deposit is a traditional way of investing money but time has changed now and people are moving towards debt mutual funds, equity funds, liquid funds, and other investment opportunities. However, FD remains a favorite investment plan for the majority of investors. Before we see NRE FD vs Debt Fund, let’s understand the basics.
If you don’t know..
A Fixed Deposit account is an investment instrument offered by almost all the banks and it generates more returns than the savings account. It comes with a fixed maturity duration and offers a fixed rate of interest after maturity. There is no need to have a separate account for FD and you can create or book an FD online within a minute.
Fixed Deposit scheme is not limited to Indian residence but available for NRIs as well. The interest rates of NRE (Non-Resident External) FD and fixed deposits in India are almost the same but there is a difference between the actual returns from both the accounts.
What Is an NRE Fixed Deposit?
NRE FD is only for the NRI i.e. Non- Resident Indians and you should have NRE (Non-Resident External) account to invest in NRE FD. You can approach any Indian nationalize bank in the foreign country you are currently residing and request to open an NRE account.
You will have to sign few pages of a bank account application form and produce following self-attested documents to open an NRE account
- Passport copy
- Indian PAN (Permanent Account Number) Card Copy
- Valid VISA Copy
- Passport Size Photo
- Letter from employer confirming your address as per their records
Once you sign and submit the required document, within 2-3 working days you will get the SMS/email with your NRE account information. Now, you can activate your online banking and mobile banking which makes smooth banking experience.
Things To Remember About NRE Account
- Only foreign money can be deposited to the NRE account.
- You need to update your KYC (Know Your Customer) updated, however, the bank will be asking you yearly.
- You can have a joint account but only with another NRI.
- You cannot keep the NRE account once your NRI status changes to Indian residents.
Once your NRE account is active, you can visit your bank or simply log in to the bank’s online portal to open a FD account. The investment procedure is similar to what we use to follow in India.
What Makes an NRE FD Different?
Even though the investment procedures remain the same with NRE fixed deposit and you get the same interest rate what people get in India, NRE FD has some additional perks like;
- Your principal and interest earned on the investment is 100% tax-free.
- Principal and interest earned are repatriable to the account holder’s country of residence.
- You can have a joint FD account but with other NRIs.
Since we already know about NRE Fixed Deposit, let’s understand what Debt Mutual Funds are?
What Is a Debt Mutual Fund?
Debt Mutual Funds are the fund houses that pool money from many investors and invest in safe and fixed return investment instruments. This investment instrument includes government treasury bills, corporate bonds, commercial papers, etc. Debt Funds are categorized into 16 types based on their maturity tenure and investment exposure in investment instruments.
To Invest in Debt Fund as an NRI, you must have NRE, NRO, or FCNR account. Once you open any one account from he mentioned account type, you can reach out to the bank directly or call your relationship manager of your bank for account setup.
Since debt funds invest only in safe investment plans, therefore, the risk involved in these funds is very minimum. Also, debt funds have more return on investment than the fixed deposit in the long run provided you have invested in the best fund. Debt funds have many benefits but since they are investing in the market, they are not 100% risk-free like fixed deposits.
Now, if you are getting second though about the debt fund investment, then look at the following chart (credit – moneycontrol) showing the steady and consistent performance. It has given more than 8% annualized returns in 10 years which is far better than the fixed deposit.
Confused? because you were looking for a different answer here i.e. FD suppose to generate more returns than debt mutual fund. FD is not worth investing anymore considering the drastic fall in interest rate but it is in India.
But let’s compare the NRE FD with debt mutual fund and understand, why NRE Fixed Deposit is better than the Debt Mutual Fund.
Why Is NRE FD Better Than Debt Mutual Fund?
If you are an NRI then you should choose NRE Fixed Deposit over Debt Funds. Following are the 2 key reasons behind my preference;
1. NRE FD Is 100% Tax-Free
Principal Amount along with the interest earned on the NRE fixed deposit is 100% tax-free.
Whereas you have to pay income tax on the debt fund returns. You have to pay a 30% tax on your Short Term Capital Gain and however, your earning is eligible for indexation and 20% interest rate if you hold the debt fund for more than 3 years.
Will it impact much considering the debt fund generate more returns than the fixed deposit?
Let’s see an example, suppose you have invested INR 1,00,000 in FD at the fixed interest rate 6% for a year and INR 1,00,000 in a Debt Fund for 2 years which has generated 7.5% annualized return in a year.
FD will generate the fixed return of INR 6,000 on maturity and Debt fund will show INR 7,500 profit. But, the debt fund return will attract Short Term Capital Gain tax i.e. 30% i.e. INR 2,250 therefore, the amount in hand will be INR 5,250 which is about 5.25% return.
Let’s suppose, you invested in these options for 3 years. Your FD maturity amount will be INR 1,19,101.60 at the 6% flat interest rate. Debt Fund in 3 years at 7.5% annualized return will result in INR 1,24,229.69.
If you apply the indexation as it’s a Long Term Capital Gain, your amount in hand (after deducting 20% income tax) will be INR 1,21,431.75. Which is good if you are lucky enough to get a good annualized return. You can use FD and Debt Fund excel calculator to try it by yourself.
2. Debt Funds Are Not Risk-Free
Debt Funds invest only in safe investment instruments like government/corporate bonds, commercial papers, and treasury bills which have fixed maturity and fixed returns. But, still there are chances of investment in bad companies by the debt fund managers which could return in an overall loss in the portfolio.
Debt fund returns depend on the market i.e. as long as companies are paying the interest. Debt Fund may show negative returns if companies in which fund has invested start defaulting payment. Usually, Debt Funds have very minimum risk but not risk-free.
Whereas with Fixed Deposit your returns are fixed and you don’t need to worry about the market. However, there were incidents (very rare) where banks itself declared bankruptcy which had created chaos in customers and FD investors. But don’t worry, each depositor in a bank is insured up to Rs 5 lakh for both the principal and interest amount on deposits held by him/her in that particular bank. Read Also. Is FD Worth Investing In 2020?
- Best Investment Options For NRIs
- Understanding NRE, NRO and FCNR Accounts
- How NRIs Can Directly Invest In the Indian Stocks?
There is no harm in finding a better option to invest money but we shouldn’t forget to consider the safety or return consistency. If you are not an NRI then I would never suggest keeping excess money in fixed deposit but since FD returns in NRE account are tax-free and fixed, I don’t see any meaning of investing in debt fund.