17/08/2014
SIP in mutual funds is better than recurring deposits scheme
SIP in Equity Funds vs Recurring Deposits
Both Systematic Investment Plan (SIP) in equity funds and recurring deposits in banks are used to create a large corpus over a long period of time.
The effect of compounding helps both deliver handsome returns.
One may argue that it won’t be fair to compare the two as they belong to different asset classes, namely equity and debt. But in times of intense volatility in stock markets and high returns offered by banks on deposits, the comparison is inevitable as to which investment option may help investors better to reach their financial targets.
Both, SIP in equity mutual funds and bank recurring deposits, require regular investments and are useful to meet financial targets.
When someone opts to invest in an equity mutual fund through SIP mode, the impact of market volatility gets minimised due to average purchase cost per unit of investment.
Units of mutual funds are bought at different NAVs over a period of time and thus more units are bought when markets are at lower levels.
When markets are falling, one should use that as an opportunity to accumulate more units, which can be sold later when the markets go up. While market volatility may impact short-term return, cost averaging helps one earn better return over a long period of time.
# For long duration
If one is looking to build a retirement corpus or a large fund for children’s education or marriage, then it would be better to opt for SIPs in some good equity mutual funds.
Over the last 10 years, diversified equity funds have returned 22.29 per cent on an average, much more than any fixed-income instruments could have offered. Even if one chose to invest in passively managed Index Funds, the return stood at 18.14 per cent over the same period.
However, the one-year, three-year and five-year returns of average diversified equity funds stood at 4.49 per cent, 5.73 per cent and 4.23 per cent, respectively, much lower than interest rates offered by banks or post offices.
# For short-term goals
Investments in recurring deposits help one achieve short-term financial goals, especially when the money is needed within five years.
Interest rates offered by different banks are still hovering at higher levels and it would be a good idea to start a recurring deposit to capitalise on higher rates.
For example, if one deposits Rs. 5,000 per month in a recurring deposit for five years that yields 9.25 per cent interest, he will get Rs. 3,81,817 at the end of the maturity. Some banks are even offering 10 per cent rate on short-term deposits.
In case of recurring deposits, the interest rate offered by the bank remains the same throughout the tenure of the investment, thus cushioning investors from interest rate volatility. Moreover, banks also allow investors to take loan against the deposit account.
# Balance in portfolio
The choice between SIP in equity funds and recurring deposits should be made based on one’s investment horizon, risk appetite and structure of the portfolio. Since the two instruments belong to different asset classes, a mix of the same helps one maintain proper balance. While the equity portion will help boost growth, the debt portion will ensure necessary stability and assured return.
# Tax perspective
However, it has to be kept in mind that although one can be sure of the maturity value of a recurring deposit, he/she needs to factor in post-tax returns also.
Though there is no TDS in the case of recurring deposit maturity, the interest amount earned will be added to one’s annual income. In case of SIPs in equity funds, there will be no long-term capital gain tax if units are sold after one year from the date of investment. From return as well as tax perspective, it pays well to stay invested in equities for longer duration.
