Fixed Deposits (FD) have been the go-to investment for ages now. But in recent times, mutual funds (MF) have become very popular due to their potential to generate higher growth than FDs. Note the key differences between mutual funds and fixed deposits before investing.
Both FDs and Mutual Funds are popular investment options in India. However, they differ significantly. Fixed Deposits are interest-earning investment options. On the other hand, Mutual Funds earn returns by investing in a diversified investment portfolio. The fund invests across stocks, debt instruments, and other assets. Mutual Funds are managed by fund managers. The associated risk, liquidity, returns, and investment duration differ for both FD and MF.
Whenever the topic of mutual funds vs fixed deposits arises, fixed deposits end up walking away with the favourable vote of confidence. For the longest time, fixed deposits were the only kind of investments that were regarded as safe and dependable.
If you are someone who grew up in India, we can easily assume that you are no stranger to the concept of fixed deposits. Any financial advice pouring in from senior family members probably included fixed deposits as a mandatory investment. Between mutual funds and fixed deposits, which is a better investment? This seems to be the most common question asked by investors today.
As the financial markets became more sophisticated with time, the investment choices continued to grow exponentially. Today there are countless financial products that cater to various financial needs of the different types of investors. One such investment option is mutual funds.
|Particulars||Mutual Fund||Fixed Deposit|
|Investments||Monthly (SIP) or Lumpsum||Lumpsum|
|Expenses||Charges for fund management – Expense Ratio.||No expenses|
|Lock in Period||No||Yes|
|Premature Withdrawal||Allowed, with or without exit load||Attracts penalty|
|Taxation||Depends on the type of MF and investment holding period.||As per income tax slab rate.|
|Who Can Invest?||Investors with good understanding of risk||Investors seeking stable and guaranteed returns.|
|Offered By||Asset Management Company||Banks and Financial Institutions|
|Impact of interest rate movements||Depends on kind of Mutual Fund||Unaffected, the interest rate is pre-determined|
For some reason, mutual funds and fixed deposits are constantly pitted against each other. When people constantly ask which is better, mutual funds or fixed deposits, it isn’t necessarily a fair comparison because these two financial products differ in one major aspect.
One of the biggest differences between mutual funds and fixed deposits is that, a mutual fund provides return on the money invested and fixed deposits offers interest payments on the money deposited. As you can see, there is a major difference between investing money (investing being the keyword here) and depositing a lumpsum in one go (depositing being the keyword here).
To help you understand better, let’s look at fixed deposit and mutual funds in detail.
A fixed deposit is a financial instrument offered by banks, post office, and other NBFCs (Non-Banking Financial Company) which offers the investors a higher rate of interest compared to regular savings or a salary account. The money invested in fixed deposits is used by the banks as capital for other business operations. One such example is issuing loans at a higher interest rate than the rate they pay to fixed deposit account holders.
To invest in a fixed deposit, you need to have that kind of money (lump sum amount) already available. Typical investors in fixed deposits are the ones who would have already accumulated surplus cash over a period of time. For this reason, fixed deposits are a popular choice of investments for retired individuals and senior citizens. Another category of fixed deposit investors are the ones who would have huge sum coming in from a sale of property or inheritance.
Now that we have learnt the fixed deposit definition. Let us learn more about how a fixed deposit works.
A fixed deposit is a type of an account opened with a bank, where a bank agrees to pay a fixed rate of interest for a particular period of time.
For example, let us assume that you invested a sum of Rs. 10,00,000 for 5 years, with a bank that offers an interest rate of 6% per annum. You would be receiving Rs. 60,000 as interest payment each year for a 5-year period. Based on your financial needs, you can choose to have this interest amount deposited into your account on a monthly basis or once every quarter or once a year.
A mutual fund is a popular financial product that pools money from multiple investors and invests that money in the equities market. A mutual fund uses the said financial resources to purchase stocks and shares of multiple companies trading on the stock market.
Investing in mutual funds, doesn’t necessarily require any surplus cash and it doesn’t have to be a lump sum investment (unless that is what you want to do). You can invest a small percentage of your monthly income in the form of SIP investments. When your income increases over a period of time, you can also increase the percentage of your income that would be set aside for SIP. For this reason, mutual funds are an ideal form of investment option for salaried professionals and individuals with some form of monthly income.
Now that we have understood the mutual fund definition, let’s learn more about how mutual funds work.
When you invest in a mutual fund, you purchase the mutual fund units (also known as unit shares) to the extent of your investment. There are two possible ways in which you can invest in mutual funds; you can either invest a lump sum amount and see how your investment fares over time or invest in the form of a systematic investment plan (SIP).
SIP refers to investing a predetermined amount on a periodic basis. Each SIP enables you to purchase additional units of the mutual fund. The value of your units held in a mutual fund is determined by the fund’s Net Asset Value (NAV)
An integral part of understanding how mutual funds work is to learn how you earn from mutual fund investments. If you opt for dividend payments, a mutual fund will payout its annual earnings as dividend payments. If you opt for reinvestment of your annual earnings back into the mutual fund, you will have the benefit of capital gain. Capital gain refers to the increase in the value of your asset, it essentially means that your asset is worth more than what you paid for it.
In addition to what is discussed above, many investors always wonder which has a better presence in India, mutual funds or fixed deposits?Traditionally, as we have mentioned earlier, fixed deposits have always been popular because the investors consider fixed deposits safe and risk-free. But as mutual funds started gaining popularity, and investors started seeing better returns, mutual funds are beginning to give tough competition to fixed deposits.
But, if you are evaluating your options and deciding between an investment in mutual funds versus fixed deposits specifically for you, the answer completely depends on your income, your monthly expenses, and your financial goals. Before you decide where and how you would like to go about investing, you need to have a clear idea about these aspects.
Now, let us learn more about how mutual funds and fixed deposits differ on certain key investment parameters.
You may also like to read about the RD vs FD vs SIP
Equity Mutual fund returns completely depend on the performance of the stock market. If the stock market continues to perform well, mutual funds offer returns accordingly. Fixed income based mutual funds tend to be more like fixed deposits in terms of their return profile. On average, a long-term mutual fund return has been around 12% looking at periods of over 5-6 years and a mid and short-term mutual fund return (debt funds) has been in the range of 6%-7%.
As mentioned earlier, fixed deposit returns are predetermined. Fixed deposit returns are guaranteed payments throughout the tenure of your investment. The average rate of return on fixed deposits has been in the range of 5% to 7%. Fixed deposit return depends on the bank you choose to open your fixed deposit account with.
Check fixed deposit returns based on different tenure:
Before we conclude, we wanted to quickly touch upon the benefits of both mutual funds and fixed deposits.
Mutual funds are investment vehicles that pool money from an investor with similar objectives and invest in different financial securities. There are mainly three different types of mutual funds, namely equity, debt and hybrid. Equity funds are affected by market movements and volatility. Debt funds are affected by interest rate changes. Whereas hybrid funds invest in both debt and equity. Hence, the fund that has the majority of the investment in equity will behave like an equity fund. The fund that has the majority of the investment in debt will behave like a debt fund.
A mutual fund that is considered safe by an investor may not be considered safe by another investor. Hence it is important for an investor to assess their understanding of risk before choosing a mutual fund. If a slight market movement creates panic among investors, then it is advised to stay away from equity funds. In this case, debt funds are considered better. If the investor prefers guaranteed or predictable returns, then debt funds that invest in government securities are a better option. Hence investors need to assess their understanding of risk along with the return expectations and choose the fund that best fits their requirement.
Explore Difference Between ETF and Mutual Funds
Debt mutual funds have the potential to generate marginally higher returns (post tax) than fixed deposits.
The goal of an emergency fund is to offer quick access to cash. While some emergencies may give you a few hours or days to arrange for, you might need money right away for others. Both liquid mutual funds and fixed deposits can be suitable for creating an emergency fund. The choice largely depends on your risk tolerance levels. Liquid funds are considered to be low risk debt mutual funds that may offer slightly higher returns (post tax) than fixed deposits. Thus you can allocate some portion of your emergency fund to liquid mutual funds.
Liquid mutual funds, ultra shor term debt mutual funds, fixed deposits, and recurring deposits are a good short term investments. Debt mutual funds are low risk investments that help in generating more or less stable returns. On the other hand, fixed and recurring deposits offer guaranteed income at the predetermined interest rate. Thus depending on your investment objective, understanding of the instruments and risk tolerance levels, you can pick a suitable instrument