Fixed deposits, which generally come in the form of bank C.D.s, have traditionally been the province of investors with a total aversion to risk of any type, based on the security factor that deposits up to a limit are insured by the government, and therefore perceived as 100% risk free. These investors also tended to be more advanced in age than the general investing population and the viability of the issuing banks is absolutely of no concern to these investors.
When bank C.D. rates were still hovering around 6% to 7%, a strong case could have been made concerning the secure validity of debt mutual funds vs. fixed deposits, although most experts would readily agree that over the long term, debt mutual funds usually outperform fixed deposits due to tax implications.
Liquidity is typically not an issue with either investment. Debt mutual funds can be almost treated as traditional bank savings accounts, with the cash out proceeds being available merely a few days later. Most banks only levy surrender or penalty charges on larger amounts, and it would be fair to assume that investors with large cash hoards in all likelihood would have other assets that can be tapped into before dipping into the C.D. reserves.
Debt mutual funds, however, have much more leeway in the types of debt instruments they can invest in, such as government and corporate debt securities that may have higher rates of return, depending on the maturity of said debt instruments. A 10% percentage of assets can also be invested in equities for capital gains purposes, and investments in REITs is not totally unheard of. Positive price movements of the underlying debt instruments can furthermore improve the total yield, with sharp eyed managers being able to provide a substantial boost during times of high volatility.
The main tax advantage of debt mutual funds lies in the fact that the proceeds can be taxed at capital gains rates, especially if redemptions do not occur until one year has passed. Interest earned on fixed deposits are taxed as normal income, at the taxpayer’s overall rate.
Alas, bank C.D. rates have been quoted at a little over 1% for 2012, even for 5 year jumbo C.D.s, and this rate is expected to extend into the rest of 2012, maybe even further if the Federal Reserve holds its course of action steady for the intermediate future, a highly likely event. With the inflation rate in the 2.5% range for 2012, investors in fixed deposits are facing a negative return on investment, even before taxes.
On the other hand, top rated debt mutual funds still returned 6% to 7% in 2011, and fast footed money managers may well still perform decently in 2012.
For the foreseeable future, the issue of debt mutual funds vs. fixed deposits mat not be much of a debate.