Weigh your investment options – The Hindu
Recurring deposits and systematic investment plans help ensure regular allocation and financial discipline
Recurring deposits (RD) and systematic investment plans (SIP) are both popular investment options among retail investors to achieve their financial goals. While one can open RD with banks, SIP is a mode of investment in mutual funds. The two have a major similarity in that they allow investors to invest a predetermined amount at regular intervals, thus ensuring regular investments and financial discipline.
However, before committing to any of the investment channels, it is important that the investor understands the possible returns as well as the risk of capital erosion.
RDs opened with listed banks are covered by the Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the RBI. This insurance program covers the cumulative deposits of each scheduled bank depositor, including RD, savings, current and FD accounts, up to 5 lakh in the event of bank failure.
Note that the insurance covers both interest and major components. This makes R&D one of the safest investment options. For those who have deposits with multiple regular banks, the 5 lakh coverage would apply separately to deposits with each bank.
SIPs can be used to invest in equity funds, debt funds, hybrid funds and gold mutual funds. Therefore, the extent of capital protection in a SIP would depend on the category of mutual fund and the sub-category in which you invest. Debt funds generally offer higher capital protection than equity funds. Among debt mutual funds, the risk of capital erosion would be lowest and almost negligible in liquid and overnight funds.
Waiting for return
The interest rate applicable at the time of the opening of an RD remains fixed until its maturity, regardless of changes in the rate of the RD card during the duration of the FD mandate. For example, if we open the two-year RD at 6% per annum, the interest rate will remain the same until the end of two years.
This provides a high level of income certainty in the DRs, even higher than what many small savings plans offer. Remember that the interest rates for most small savings plans are reviewed by the Ministry of Finance every financial quarter.
The returns of SIPs depend on the performance of the selected fund. However, regular and automated investments through SIP allow the average cost in rupees to be calculated during downturns and market corrections.
As a predetermined amount is automatically deducted regardless of market level or net asset value, SIP equity-focused mutual fund investors automatically end up getting more shares at lower NAVs during bear markets. .
Most banks charge an early withdrawal penalty of up to 1% for premature RD closure. In the case of SIPs, liquidity would depend on the liquidity characteristics of the invested mutual fund. Those who invest in equity savings plan funds (ELSS) via SIPs can only withdraw units purchased at least three years ago. While other categories of mutual funds do not restrict redemption, most funds take exit charges of up to 2-3% on redemption before a preset time. However, there is no exit charge for short-term debt funds such as very short-term, liquid, overnight debt funds, and most low- and short-term debt funds.
As a result, short-term debt funds have beaten the DRs in terms of the cost incurred in unscheduled redemptions. Likewise, equity mutual funds also outperform RDs in terms of flexibility over unplanned redemption costs, as most equity mutual funds do not charge an exit charge after one year of investing.
Interest income generated from your R&D returns is clubbed with your annual income and taxed according to your income tax bracket. In the case of SIPs, the taxation would depend on the type of mutual fund and the holding period.
Earnings – short term vs long term
In the case of equity-oriented funds, capital gains recognized on redemptions of investments within one year are subject to a short-term capital gains tax (STCG) of 15%. Gains recorded on the redemption of shares in equity-based funds after one year of investment are considered long-term capital gains (LTCG) and are subject to a 10% tax on gains above 1 lakh in the period. during an exercise. In addition, SIPs of ELSS funds are also eligible for a tax deduction of up to 1.5 lakh per fiscal year under section 80C.
In the case of debt UCITS, the capital gains recorded on the redemption of debt funds after three years of investment are considered as LTCG and are taxed at 20% with the benefits of indexation. Returns posted on the repayment of debt funds within three years are considered STCG and are taxed according to the investor income tax slab.
(The writer is director, Paisabazaar.com)