FD vs Mutual Funds
Navigating the choice between fixed deposits and mutual funds can be a difficult task, as each comes with its unique set of advantages and drawbacks. Fixed deposits offer stability with minimal market risk, while mutual funds are subject to market fluctuations. Banks typically provide fixed deposit services, whereas specialised fund houses or asset management firms offer mutual funds. In this blog, we’ll highlight the key distinctions between fixed deposits and mutual funds, helping you determine the most suitable investment option for your financial goals. Let us now explore the various specifics of the debate between FD vs Mutual Funds.
What are Fixed Deposits?
A fixed deposit represents a financial tool available through banks and non-banking financial companies (NBFCs). With this option, you can deposit a lump sum of money for a specified duration and, in return, earn a predetermined interest rate.
Throughout your deposit term, the interest rate on your fixed deposit remains constant. You’ll receive your initial principal amount and the accrued interest when the term concludes. Fixed deposits are known for their relative safety, guaranteeing a stable return and protecting your invested capital. To determine the final maturity amount of your fixed deposit, you can take advantage of an online FD Calculator.
What are Mutual Funds?
A mutual fund, a widely used financial product, combines investments from multiple individuals and allocates those funds to the stock market. It utilises these resources to acquire stocks from various companies in the stock market.
Mutual funds don’t require a surplus of funds or a lump sum investment unless you choose that approach. You can begin by investing a small portion of your monthly income through Systematic Investment Plans (SIPs). As your income grows over time, you can increase your SIP contributions. This makes mutual funds an ideal option for salaried professionals and those with regular monthly incomes.
Difference Between Mutual Fund and Fixed Deposits: FD vs Mutual Funds
The following is a comparative analysis of FD vs Mutual Funds:
| Aspects of Difference | Fixed Deposits | Mutual Funds |
|---|---|---|
| Returns | Fixed interest rate | Market-linked performance |
| Risk | Often low | Low to high, depending on the type |
| Costs | No associated expenses. | Investors who are looking for stable returns and do not have a risk appetite. |
| Liquidity | Limited liquidity | Generally high liquidity |
| Lock-in Period | There is usually a lock-in period. | There is no lock-in period, usually. |
| Investment Amount | Specified minimum amount; often no maximum. | Specified minimum amount; often no maximum |
| Who Can Invest? | Investors who are looking for stable returns and do not have an appetite for risk. | Investors with a risk appetite and investment knowledge. |
| Tenure | Fixed duration (1 to 10 years) | Flexible tenure based on investor preferences |
| Taxation | Taxable as per applicable criteria. | Subject to taxation per prevailing rules and regulations. |
| Offered by | Banks and other non-banking financial companies (NBFC) | Asset Management Company (AMC) |
| Fund Management | No fund management is necessary. | There is a need for fund management. |
| Regulating Authority | RBI | SEBI |
Now that we have explored the difference between FD and Mutual Funds let us look at some similarities.
Similarities Between Fixed Deposits and Mutual Funds
While fixed deposits and mutual funds are distinct in their approach, they share some common features that investors in India should consider:
- Investment Safety: Fixed deposits offer low risk with guaranteed returns. Mutual funds carry varying levels of risk but can mitigate this through diversification, depending on the fund type.
- Minimum Investment: Both options allow investors to start with small amounts. Fixed deposits require a minimum deposit set by banks, whereas mutual funds enable affordable contributions via systematic investment plans (SIPs).
- Regulatory Oversight: Both are regulated by authoritative bodies—fixed deposits by the RBI and mutual funds by SEBI—ensuring investor protection.
- Liquidity: Both offer liquidity, though with conditions—fixed deposits may have penalties for early withdrawals, while mutual funds usually allow redemptions but might have exit loads imposed on premature withdrawals.
FD vs Mutual Funds: Which is Better?
Indian investors have traditionally relied on fixed deposits due to their safety and guaranteed returns. However, mutual funds present a strong alternative with the potential for higher returns and more favourable taxation, particularly for long-term equity investments. Unlike fixed deposits, where interest is taxed annually, mutual fund taxation is deferred until redemption.
Mutual funds can be better at combating inflation, especially over the long term. While some investors are wary of their inherent volatility, it’s important to note that not all mutual funds share the same risk level. New investors can start with less risky funds like debt or hybrid options and gradually explore higher-return alternatives. However, choosing between fixed deposits and mutual funds ultimately depends on individual financial goals, risk appetite, and investment horizons.
Who Should Invest in Fixed Deposits?
Various individuals may find Fixed Deposits (FDs) appealing:
- Risk-Averse Investors: FDs are favoured by those prioritising low-risk investments as they offer guaranteed returns on a fixed interest rate.
- Senior Citizens: Banks commonly offer higher interest rates on FDs for senior citizens, making them an attractive choice for older individuals seeking secure investments with better returns. Fixed deposits are now available on smallcase. Learn more about them here!
- Income Tax Savers: Tax-saving FDs, eligible for deductions under Section 80C of the Income Tax Act, enable taxpayers to save up to Rs. 1.5 lakh on their income tax liabilities. Consequently, those seeking to reduce their tax burden can explore these FD options.
Who Should Invest in Mutual Funds?
Mutual funds can be suitable for individuals with specific financial goals and strategies:
- Seeking Higher Returns: Mutual funds have the potential to deliver higher returns compared to traditional bank deposits over time. However, they come with associated market risks and require a reasonable investment horizon to mitigate volatility.
- Diversification Goals: Mutual funds invest across various assets, such as equities, bonds, and securities, offering an accessible way to diversify a portfolio. This diversification helps distribute risk.
- Long-Term Investment Perspective: For those with a long-term outlook, mutual funds, particularly equity funds, have historically shown the potential for significant growth, often surpassing fixed deposits. However, they remain subject to market fluctuations.
- Tax-Saving Opportunities: Equity-linked savings schemes (ELSS) are mutual funds eligible for tax deductions under Section 80C of the Income Tax Act. Investments up to Rs. 1.5 lakh in a financial year qualify, although gains on redemption exceeding Rs. 1 lakh are subject to long-term capital gains tax.
Comparative Analysis of the Benefits of Investing in FD vs Mutual Funds
Understanding the unique benefits of fixed deposits (FDs) and mutual funds is essential for making informed investment decisions. Each has its strengths, and a comparative overview can help evaluate them against your financial objectives.
Benefits of Fixed Deposits (FDs)
- Guaranteed Returns: FDs offer fixed interest rates, ensuring predictable returns for investors.
- Low Risk: They are considered low-risk investments, with up to Rs. 5 lakh per depositor insured by the DICGC.
- Flexible Tenure: Investors can select tenures ranging from 7 days to 10 years based on their financial goals.
- Senior Citizen Benefits: Senior citizens often enjoy higher interest rates on FDs.
- Tax Benefits: Tax-saving FDs under Section 80C offer deductions up to Rs. 1.5 lakh. However, the interest earned is taxable.
Benefits of Mutual Funds
- Potential for Higher Returns: Mutual funds, especially equity funds, have historically offered higher returns over the long term, though they involve market risks.
- Diversification: By investing in various asset classes, mutual funds help reduce risk and improve portfolio balance.
- Professional Management: Managed by experienced professionals who base decisions on market research and analysis.
- Liquidity: Most mutual funds provide easy access to funds, allowing investors to redeem units on business days.
- Tax Efficiency: ELSS funds qualify for Section 80C deductions, with gains taxed only upon redemption. Gains above Rs. 1 lakh are subject to long-term capital gains tax.
To Wrap It Up…
The choice between FDs and mutual funds depends on your risk tolerance, investment horizon, and financial objectives. FDs provide stability and safety, while mutual funds offer growth potential and diversification. Understanding these benefits will help you make an informed decision that aligns with your investment goals.
Frequently Asked Questions About FD vs Mutual Funds
FDs are deemed safe but offer lower to moderate returns, whereas mutual funds present the potential for higher returns and increased risk. Ultimately, which investment is better depends on the individual investor and their investment objectives and risk tolerance.
FDs are considered the safest investment due to their guaranteed interest and principal upon maturity. However, it’s important to note that the liquidity and safety of FDs rely on the financial solvency of the bank or financial institution.
All investments entail risk, but mutual funds are generally considered safer than buying individual stocks because they provide greater diversification by holding multiple company stocks within a single investment.
Debt mutual funds can yield slightly higher post-tax returns compared to fixed deposits.
