To Risk or Not To Risk: Choosing between Fixed Interest and Market-linked Instruments
Historically, Indian retail investors have favored Traditional products for investment, such as FD, Insurance Plans of LIC (not ULIPs), etc. Though our financial industry has grown manyfold over 25–30 years, higher investment has remained in traditional products. as per the RBI Bulletin on Financial Assets and Liabilities of Households (December 2022), almost 35% of the total financial assets of households are in Bank Deposits, 22% in Life Insurance Products (again, not ULIPs), 30% in PPF, 17% in other Small Saving Schemes and only 8% in Mutual Funds. If we compare these data with other developed countries, such as the USA, Indian Households are far behind. In the USA, more than 50% of investment is in Mutual Funds.
One reason for low investment or less interest in market-linked products is the lack of education and awareness.
In this blog, I will throw light on why it’s high time to switch to Market Linked Products. Keep reading…
Market Linked vs. Non-Market Linked Investments
Market-linked products are related to the market and invest in market instruments such as stocks and bonds. Their performance is market driven and does not guarantee any return. Market-linked products include Mutual Funds, Unit Linked Insurance Plans, etc.
Non-Market Linked products, on the other hand, come with safety of return and capital protection. The return is somewhat predictable and there is no risk of losing the capital, e.g. Fixed Deposits of Bank, wherein interest rate is fixed and capital is protected.
However, the drawback of investing in Non-Market linked products is that they are not able to cope-up with inflation. Interest rates are declining year on year and the inflation-adjusted rate of interest is minimal. Further, the income received from these products is taxable every year.
In this scenario, Market Linked products become your savior, because historically, they have given handsome returns. Furthermore, income from these products is taxable only in the year of sale and not every year, in form of Short-Term or Long-Term Capital Gain. Again, Long-Term Capital Gain comes with an indexation benefit.
Why Market-Linked Products offer High Returns?
Because of the risks associated with it. Market-Linked products carry risk and do not guarantee any return. Hence, to compensate an investor for the risk he is taking, a higher return is offered. It should be noted that Risk and Return are interrelated — The higher the Risk, the Higher the Return.
Market Linked Products are Tax Friendly
As discussed earlier, Market-Linked Products are tax-friendly, as compared to Non-Market-Linked Products. Interest on FD is taxable every year and post-tax return is low when adjusted with the inflation rate.
Mutual Fund and Stocks are taxable only in the year of sale. Short-Term Capital Gains (when the holding period is less than 12 months) are taxable at 15%. Long-Term Capital Gains (when the holding period is more than 12 months) is taxable at 10% and that too, when the gain exceeds Rs. 1.00 Lakhs. In the case of Debt Funds, the holding period is extended up to 36 Months, up to which, the Short-Term Capital Gain is taxed as per the normal slab rate of the taxpayer. Beyond 36 months, it is treated as the Long-Term Capital Gain and taxable at 20% with an indexation benefit.
Points of Caution
Market Linked Products are subject to market risk and do not provide any guarantee of return or return of capital. Hence, it is advisable to evaluate the risk profile of an investor first — how much risk he/she is willing to take or if they are willing to take any risk at all. However, the upside is, it offers higher returns as compared to traditional products and even beats inflation.
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