Bank FDs offering 8-9% interest rate or debt MFs: Where to invest for the short-to-medium term?

economictimes.indiatimes.com:

Some small finance banks are giving lucrative fixed deposit options. Is it advisable to opt for such FDs that offer 8-9% returns, instead of a normal debt mutual fund for short- to medium-term investment?

Naveen Kukreja, Co-Founder and CEO, Paisabazaar.com: Fixed deposits with small finance banks offer higher capital protection and income certainty than debt mutual funds. The RBI has granted the status of scheduled banks to all existing small finance banks.

Hence, depositors in small finance banks qualify for the quasi-sovereign guarantee cover offered through the Depositor Insurance Scheme of DICGC, an RBI subsidiary. In case of bank failure, this insurance program will cover each depositor of each scheduled bank for cumulative deposits, including fixed, current, savings and recurring deposits, of up to Rs 5 lakh. This cover puts small finance banks at par with PSU banks or large private sector banks in terms of capital protection for deposits of up to Rs 5 lakh.

On the other hand, debt mutual funds are market-linked products, which makes them prone to interest rate risk and credit risk in varying degrees. The rising interest rate regimes adversely impact the returns of debt funds, as bond prices and interest rates have an inverse relationship. The opposite would be true during falling interest rate regimes.

Thus, consumers can opt for high-yield FDs of small finance banks, especially if these are offered at higher interest rates for longer tenures. This will allow them to earn higher FD yields even after the reversal of the interest rate regime. Those with a slightly higher risk appetite can start investing in debt mutual funds once the trend of falling interest rates becomes clearly evident.