Mutual Funds vs Traditional Investment Options

Published On: 24-Apr-2020

Traditionally, India has had a higher household savings rate. However, such savings went towards traditional investment products, which used to offer guaranteed returns, even when such returns were relatively lower. The love of Indians towards physical assets has been eternal, and thus, a part of savings used to get channelized into tangible assets like gold, and real estate.

Over the past few years, mutual funds have been emerging as preferred investment products amongst retail investors for several benefits investors get through investing in mutual funds. Mutual funds pool the money of investors and create an investment portfolio comprising of several securities as per the investment mandate. 

Professional fund managers make the investment decisions in mutual funds, further backed by a team of research analysts. As such, mutual funds are suitable for such investors who are not much aware of financial markets but still wish to have investment exposure into them.

One may choose to invest in a wide range of mutual fund schemes offered by different fund houses, which may be equity schemes, debt schemes, hybrid funds, solution-oriented schemes, etc. The investor may choose the mutual fund scheme to best suit their risk profile, financial goals, and investment horizon. 

Further, depending upon the asset class and holding period, the rate of tax on returns from mutual funds differs. For equity schemes, investing more than 65% of its assets in equity shares of domestic companies, gains from mutual fund investments with a holding period of less than 12 months are classified as Short-Term Capital Gains (STCG) and taxed at 15%. 

On the other hand, Long Term Capital Gains (LTCG) from equity schemes with holding period of 12 months or more is taxed at 10% (after Rs. 1 lakh annual exemption on aggregate LTCG from all equity shares and equity schemes in a year). On the other hand, STCG from other funds with a holding period of less than 36 months are taxed at the regular tax rates applicable to the investors. LTCG with extended holding period is taxed at 20% after providing the benefit of indexation.  

What are the differences between mutual fund investments and traditional investments? 

Mutual Fund vs PPF

Public Provident Fund (PPF) account can be opened at various nationalised banks and post offices and comes with a tenure of 15 years. Contributions made in such an account is eligible for tax deduction under Section 80C of the Income Tax Act, 1961. As against the market-linked returns provided by mutual funds, PPF delivers a fixed rate of interest on the outstanding balance. 

The rate of interest is notified by the Govt. of India, and the current interest rate as applicable for the quarter of January 2020 to March 2020 is 7.9% per annum. While the interest on PPF account is also exempt, the returns from mutual funds are taxed as per the rates applicable. However, the guaranteed nature of returns in PPF accounts limits the wealth creation potential of such accounts, which is not the case with mutual funds. With long term investment horizon as in PPF accounts, ELSS funds may be a better investment product aiming at wealth creation.

Mutual Fund vs Bank Deposits

Similar to PPF accounts, bank deposits also provide fixed returns, which is set at the time of initiation of the fixed deposit. The currently applicable interest rates on fixed deposits offered by different banks for one-year tenor range from 6% to 8%. Further, such interest income is also taxable in the hands of investors. As such, post-tax returns are even lower for the investor.

Mutual Funds vs Gold Investments

Several Indians prefer investing in gold as it carries social as well as emotional values for them. However, gold investments, being in physical assets, may call for additional expenses towards security and maintenance. Further, there is always a risk of impure gold, which may affect the value of the asset significantly. 

On the other hand, if the investor wants to have an investment exposure towards gold, one may choose to invest in Gold ETF. It can eliminate the risks and costs of investing in physical gold like security costs, purity risk, etc. while providing similar returns as generated by gold in the bullion market. 

Mutual Funds vs Life insurance investments

Life insurance policies are primarily an insurance product, and one should not consider it an investment product. Insurance aims to mitigate the risk of future uncertainties, and clubbing insurance and investments together may not be a desirable option for investors. Instead, one may choose for pure term insurance policy and invest the balance insurance premium saved in mutual funds. 

Further, while the insurance premium paid may provide an additional tax benefit to the policyholder, the potential of higher returns with mutual funds may well compensate for such opportunity cost. The investor may also opt for Equity Linked Savings Scheme (ELSS) to avail tax benefit on mutual fund investments as well under Section 80C. 

While mutual funds may be a great partner in the investment journey of investors, the final selection of investment products should be based on various investment considerations, as discussed above. 

Note: The tax rates mentioned in the article are for illustrative purposes only, and are updated as per the Union Budget 2020 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.