Fixed Deposits (FDs) have been one of the most popular investment avenues with Indians historically. Nonetheless, Mutual Funds (MFs) are also catching up fast. So the oft asked question for a new investor might be, Fixed deposit vs. mutual fund — which is the better option?
In this article, we have juxtaposed these two popular investment avenues and touched upon their basic attributes, advantages and limitations. Reading this article should help you easily understand the difference between FDs and Mutual funds and identify how well they suit your needs.
So, what is a fixed deposit?
FDs are fixed-income investment instruments which pay you interest at a pre-specified frequency and at a predetermined rate. For example, a 2-year deposit with SBI pays you 6.25% interest annually.
A bank, NBFC (Non-Banking Financial Institution) or any other authorised entity accepting fixed deposits is obligated to return your principal upon maturity along with any interest due thereof. Thus, FDs are classified as low-risk financial assets.
What are the benefits of investing in FDs
How safe is the money invested in FDs?
Fixed Deposits or FDs are ideally suitable to those investors who seek the safety of their capital and want to receive regular income on their investments.
It’s noteworthy that even though FDs carry low risk to capital, the financial health of a deposit-accepting entity decides how safe your principal is and whether or not you will receive a regular interest income.
Deposit Insurance and Credit Guarantee Corporation (DICGC) shields an investor from any loss of capital or interest up to Rs 5 lakh (per bank). But you need not go that far. In general, depositing your funds with frontline banks, NBFCs and deposit-accepting companies keeps your FD secure.
Pro tip: Avoid investing in any unregulated deposit scheme. While their promises may seem attractive, such schemes have a shaky track record and investors have lost a great deal of money in them.
What is the cumulative option offered by fixed deposit schemes?
Sometimes, deposits can be cumulative and have just one payout at the time of maturity. In such cases, banks/NBFCs either offer compound interest which accrues throughout the tenure or set applicable interest rates slightly higher as compared to those with payout options.
Do Fixed Deposits offer tax benefits?
Unless otherwise stated under income tax law, FDs don’t get any favourable tax treatment and the interest component is added to the taxpayer’s income under ‘income from other sources’ and taxed at applicable slab rates.
However, an FD variant called Tax-saver FDs (with a 5-year maturity) offer you tax deductions u/s 80C.
What are mutual funds?
A mutual fund is a trust that collects money from investors. The Sponsor/promoter of a mutual fund establishes the trust and appoints trustees. An Asset Management Company (AMC) is responsible for managing investors’ money for a fee and reports to the trustees.
Where do mutual funds invest?
Unlike FDs, mutual funds cater to multiple asset classes such as equity, debt and precious metals amongst others. Mutual funds can also invest overseas and are allowed to take exposure to Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs).
AMCs launch schemes classified under various mutual fund categories based on their risk-return profiles.
Mutual fund investors are allotted units at a Net Asset Value (NAV) against their invested capital. NAVs are market-driven and depending on their movement, investors make profits or losses.
What are the benefits of investing in mutual funds?
Is it safe to invest in mutual funds?
Securities and Exchange Board of India (SEBI) regulates mutual funds. The regulatory environment in India is strict and adequate to ensure investors’ safety. However do remember that as market linked instruments, Mutual fund returns are not fixed.
For instance, if you invest Rs 1 lakh in a mutual fund scheme when the NAV is Rs 25, you will get 4,000 units. Suppose, a year later NAV of the scheme rises to Rs 30, you will make a profit of Rs 20,000 (Rs 5 X 4,000 units). But if it drops to Rs 20, you will make a loss of the equal amount.
Under normal circumstances, overnight funds are considered the safest (not risk-free) and sector and thematic funds the riskiest.
Fixed Deposit Vs Mutual Fund
| Parameter | Fixed Deposits | Mutual Funds |
| Risk profile | Very low. Investors' money is very safe with regulated, profitable financial institutions/companies having strong balance sheets | Depends on the scheme category. Overnight funds carry the lowest risk while sector and thematic funds expose investors to the highest risk |
| Return potential | No scope for capital gains. Returns may not match the rate of inflation | Equity mutual funds tend to generate inflation-beating returns. Debt mutual funds may generate higher real returns for investors falling in the highest tax slabs |
| Liquidity | Easily available but usually comes at some penalty | Easily available. However, the redemption proceeds are subject to fluctuations in the NAV |
| Taxation | Interest is taxable | Dividends are taxable. Short Term Capital Gains (STCGs) on equity schemes attract 15% tax and Long Term Capital Gains above Rs 1 lakh in a financial year at taxed at 10% flat. STCGs on non-equity schemes are added to the investor’s income. LTCGs are taxed at 20% with indexation |
| Regulated by | RBI (MCA, in the case of non-banks-non-NBFCs) | SEBI |
(For illustration purposes only; under no circumstances should be construed as investment advice)
To sum up
FDs and MFs together can offer you immense diversification opportunities and thus can form a significant part of your portfolio of financial assets. Instead of considering them as alternatives, try using both, following a personalised asset allocation plan that best represents your risk appetite and helps you build an investment corpus for your financial goals.
Disclaimer:
The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a reason to buy/hold/sell any stock or a mutual fund. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.
Mutual Funds are subject to market risks and you should pay close attention to risk factors before investing. We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances.
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.
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