Many Indian investors are still seen opting for the same traditional investing options that may have worked in earlier times. The falling interest regime that on for last few years, drove quite a few of these investors towards Mutuals Funds, but after the recent interest rates hike and its subsequent impact on fixed deposit rates, many investors are seen asking whether traditional investments are now a good investment option?
Traditional investments were the darling of the investors because they seemingly offered security and comfort. But they also have a major, and often overlooked, side effect; which is the negligible growth of wealth.
Taxation: If you fall in the highest tax bracket, i.e. 30 per cent & if we assume a 7 per cent interest rate on a traditional instrument, the effective return is barely 4.8 percent
Inflation: Inflation is the rate at which prices are rising. If we take the latest figures, then the inflation rate is 5 per cent in India. This means that each year, money loses its value by 5 per cent. With a 4.8 per cent return on traditional investments after tax, you will effectively be earning negative real returns after we factor in inflation.
Source: Government of India Ministry of statistics and programme implementation Central statistics office
Investors are advised to consult their tax advisor in view of individual nature of tax benefits.
Locked-In: If you invest in a traditional investment which will levy a penalty on premature withdrawal (most of the times), you may lose further capital in case you need money in an emergency.
Go for New-age Options: It is therefore time to explore other options and move beyond traditional investments.
Debt mutual funds (MFs) is are a better option for investors who want security and comfort, but also want inflation-adjusted returns. These funds do not invest in stocks; instead, they invest in secure assets like bonds, government securities, etc. and highly rated funds. Here is why you should consider debt funds:
Better tax-wise: Debt funds are tax efficient if held for over 3 years; the gains on them are treated as long term capital gains and they are taxed at 20 per cent after indexation. As indexation takes into account inflation during the period the investment is held, the acquisition price is raised and this results in lower taxes.
Suitable in all interest rate environments: Debt funds can be suitable for all interest rate environments as many funds try to maintain a high interest rate on an ongoing basis. They can adjust instruments that they hold according to prevailing interest rate scenarios.
Professional Fund Management: With a debt mutual fund, you do not have to select bonds and securities on your own; you can take advantage of the expertise of a professional fund manager.
So as you can see, while various traditional investment options may lock you in at a fixed interest rate, which is fully taxable, they can also be illiquid. Additionally, with inflation on the rise, the interest income you are left with post-inflation and taxes is negligible.
Instead, you can opt for tax-efficient and inflation-fighting debt funds,that can potentially give you better inflation-adjusted returns.
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