As investors, we have many investment options available to us. However, two investment options never fail to create the buzz- Fixed Deposits (FDs) and Mutual Funds.
Fixed deposits continue to hold the largest share (18%) of India’s total financial wealth, suggested a report by the Boston Consulting Group.
On the other hand, Asset Management Companies (AMCs) which manage mutual funds, currently own assets worth Rs. 24.46 trillion in India.
So, ranking bank FDs and mutual funds as two of the most popular investment instruments in India is not wrong.
So, which one gives the better return – fixed deposit Or mutual funds? Where should we park our money? Let us find out.
Fixed Deposits and Mutual Funds: An Overview
Before dwelling on which is better – fixed deposit or mutual funds, let’s understand what they mean and how they work.
A fixed deposit is a savings instrument offered by banks and non-banking financial corporations (NBFCs). It offers a fixed rate of return over a fixed period.
We can choose an investment tenure ranging anywhere between 7 days to 10 years. However, liquidating the fixed deposit funds before the maturity tenure will attract a penalty.
On the other hand, a mutual fund is a market-linked instrument. It is managed by a fund manager who collects money from different investors to invest in a basket of securities.
These securities could be equities, debt instruments, and/or money-market assets. Due to its market linkage, mutual fund returns are subject to market risks.
Most mutual funds do not come with a lock-in period. We can liquidate them whenever required. There is only one exception – Equity-Linked Savings Schemes (ELSS). These are tax-saving mutual funds that have a lock-in period of 3 years.
Benefits of Investing in Mutual Fund Schemes and Fixed Deposits
Both mutual funds and fixed deposits offer unique benefits. Let us now understand them:
Benefits of Investing in Mutual Funds
Following are some of the key benefits of investing in mutual funds:
- They allow us to reap the benefits of investing in multiple market-linked securities, without overstepping our budget.
- We can start investing with as low as Rs. 100 through a Systematic Investment Plan (SIP).
- Mutual funds are managed by financial experts who monitor the fund and allocate assets based on our needs.
- The Securities and Exchange Board of India (SEBI) regulates mutual funds. Hence, the risk to our investments is potentially minimal despite the market linkage.
- Mutual funds come in various forms, allowing us to choose per our return expectations and risk appetite.
Benefits of Investing in Fixed Deposits
Following are some of the key benefits of investing in fixed deposits:
- They provide assured returns.
- We can open a fixed deposit with as little as Rs. 1000. There is no maximum investment limit. However, the minimum investment amount varies from one financial institution to the other.
- 5-year FDs qualify for a tax deduction of Rs.1.5 Lakh under Section 80C of the Income Tax Act.
- Senior citizens enjoy slightly higher interest rates on their fixed deposits.
- Interest income on FDs is exempt from tax up to Rs. 50,000 for senior citizens under Section 80 TTB of the Income Tax Act.
Which Offers Better Returns? – Mutual Fund Vs Fixed Deposit
Fixed deposits offer a fixed rate of return which is generally lower than mutual fund returns. However, once opened, an FD account carries the same rate of interest for its entire tenure. Hence, with FDs, we can expect to earn a fixed return, regardless of prevailing social-economic conditions or market volatility.
Contrarily, while mutual funds offer generous returns, the risk to capital cannot be 100% overlooked.
To maximize returns from mutual funds, holding the investment for a longer term is advisable. It helps even out the market fluctuations present in the short term.
This is true for FDs also, as banks and NBFCs offer a higher fixed return if the FD tenure is longer.
Mutual Funds Vs Fixed Deposits: Differences
Below, we have listed the major differences between mutual funds and fixed deposits:
- Rate of Return
The return offered by fixed deposits for different tenures generally ranges between 6%-8%. In mutual funds, the returns depend on whether the fund is equity or debt oriented. For debt mutual funds, returns generally range between 7%-9%. Whereas for equity mutual funds, returns can go by 15-20%.
- Risk Level
Another important factor to consider is investment risk. For fixed deposits, the risk is very low since the returns are fixed. Whereas, for mutual funds, the risk level could be anything from low to moderate to high, depending upon the fund’s asset allocation. Generally, equity funds feature a high level of risk than debt funds.
Fixed Deposits are not liquid as withdrawing funds before the completion of the investment tenure attracts penalties. However, mutual funds do not come with such limitations. The only exception here is the ELSS. To stop investing in this tax-saving fund before 3 years, we must pay an ‘exit load’.
Fixed Deposits come with zero charges, i.e., creating an FD does not include added charges. All we need is an active bank account. However, in the case of mutual funds, a nominal charge is involved. Called the Expense Ratio, it is charged to ensure smooth management of the fund by the AMC.
Both fixed deposits and mutual funds are excellent investment options. The former provides assured returns. In contrast, the latter offers benefits like higher returns and professional management of funds. While both investment instruments are unique, when placed in an investor’s portfolio, they complement each other. Hence, if portfolio diversification is our objective, then we must consider investing in both.
Beyond portfolio diversification, there are other factors to be considered. These include our risk appetite, investment objective, and return expectations. From the standpoint of risk, FD makes for a wiser choice. On the contrary, if earning higher returns is our goal, then mutual funds score over FDs.
Moreover, FDs come with a lock-in period, and liquidating the deposits isn’t straightforward. Therefore, we must also base the decision on our liquidity needs. If having consistent access to money is a necessity, we must opt for mutual funds.
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Can the value of my mutual fund investments drop to zero?
Theoretically, the value of mutual funds can drop to zero since it is market-linked. However, practically speaking, the chances of investors losing their entire investments are rare. Mutual funds are managed by professionals who allocate assets across a basket of securities. So, the value of a mutual fund investment can drop to zero if each of these securities fails. This, itself, is a rare possibility.
How can I liquidate my FD funds?
There are two ways to liquidate the FD amount: withdrawing prematurely and using the FD as collateral for loans. While premature withdrawals attract a penalty, securing a loan or overdraft against FD is better. Not only do banks charge a lesser interest rate on these loans, but we also pay interest only on the money withdrawn and not on the approved value.