Ask your parents about how to save regularly and chances are that they will recommend bank recurring deposits (RD). But before you put your hard earned money in RDs, there is another alternative to RD which offers potentially higher returns and is far more tax efficient.
The instrument in question here is SIP or Systematic Investment Plan - A financial product offered by Mutual Fund houses. It is similar to bank RDs in its basic function, the difference being that in SIPs, money is invested in stock markets whereas in RDs, money is invested in government debts.
Now the question arises that if both products are similar, which one is better for you as an investor? The answer to this question depends on your investment horizon, your risk appetite and potential returns & tax treatment of both products.
Return on investment
Historically, good Indian equity MFs have delivered annual returns exceeding 15% - 18%. But please note that this doesn’t mean that you will get more than 15% return every year. It rather means that in one year, returns might exceed 15% whereas in another, it might be less than 15% or even negative. But if investment is made for more than 5 years, then average returns exceeding 15% can be achieved. There are some mutual fund schemes which have delivered more than 24% average returns for more than 10 years! That is equivalent to doubling your investment every 3 years!
Let’s take an example to better understand how SIPs provide superior returns to RDs. Suppose you invest Rs 10,000 every month in RD for 15 years and you also invest the same amount via SIP for same period. RDs generally offer 7-8% interest rates. Using 8% for RD calculations and 15% for SIP, you will end up with Rs 34.6 Lacs from your RD and Rs 66.8 Lacs from your SIP. In both cases your total investment was Rs 18 Lacs. But final value of your investment is much more in case of SIP.
The tax angle
From a taxation perspective, SIPs in MF are more efficient. In case of RD, interest amount earned is added to your total income and taxed as per your applicable income tax slab. But in case of SIP in equity funds, there is no long-term capital gain tax if MF units are sold after 1 year from the date of investment.
So the question is...which one should you choose?
In terms of investment horizon, the thumb rule says that if you want to invest for less than 5 years, then you should stick with RD. That is because in short term, stock markets can be volatile and overall returns of SIP may not be in line with historical averages. But if your investment horizon is of more than 5 years and you have a risk appetite to remain unaffected by short term market volatilities, then you should invest in via SIP in well diversified equity mutual fund schemes instead of putting money in RD.Tweet