Fixed deposits and mutual funds are one of the very popular investment choices. Both options provide investors with promising returns to help them realize their goals well within time.
When making a comparison between two things, it is necessary to bring both at the same level and then draw a comparison. That is a sane comparison. But with fixed deposits and mutual funds, this cannot be the case. Both are very distinctively different financial products. Thus, we draw an overall picture rather than pointing too deep.
Where fixed deposits offer guaranteed returns at pre-fixed interest rates, mutual fund investments provide variable returns depending upon how the market performs.
Firstly, let us look at the definitions of the two investment vehicles.
What are fixed deposits?
The very term is quite self-explanatory as in an investment option in which the rate of interest is fixed at the time of booking and interest is calculated on this interest rate throughout the tenure. Returns are decent while the risk is limited, often negligible.
To know more: What is Fixed Deposit?
What is a mutual fund?
A mutual fund is another type of investment instrument where many investors put in their money to reach a common goal. Once the income is generated, it is proportionately distributed among the mutual fund investors based on their initial deposits made.
This is more like a pool of money and is market-linked. This attracts both – higher returns and risk too.
To know more : what is Mutual Funds?
Here we draw a comparison between the two investment instruments to help our readers get a clear picture of how fixed deposit investments are different from mutual fund investment and which works well for them.
Now, let us understand the difference between the two options of money multiplication by drawing a comparison between both.
Fixed Deposit vs Mutual Fund
|Parameter||Fixed Deposit (FD)||Mutual Fund (MF)|
|Investment via||Directly with the bank/company||Directly with fund houses or indirectly via distributers/brokers|
|Withdrawal||The penalty is imposed on premature withdrawal which constitutes lowering of the interest rate at which due returns are to be paid
(Some banks may not charge any penalty)
|MF is an open-ended investment and can be withdrawn anytime without penalty
(Some funds come with pre-specified periods, mostly 3 days and exit load is to be paid if withdrawn before this period)
|Taxation||TDS @ 10% if interest in a FY crosses Rs. 40,000 (Rs. 50,000 for senior citizens)
It is 20% if PAN is not submitted
|Returns earned from MF are subject to short term or long term capital gains, whichever is applicable.
STCG: 15% on interest above Rs. 1 lakh
LTCG: 10% on interest above Rs. 1 lakh
How is an investment in mutual funds different than investing in a fixed deposit?
To invest in a fixed deposit, one needs to deposit a certain amount in the bank/ company. At the time of deposit, the depositor is promised an FD rate at which interest will be calculated throughout the tenure chosen by the depositor. On completion of FD tenure, the entire deposit, as well as the interest earned, is returned to the depositor.
To invest in a mutual fund, an interested person first needs to have an investment account after completion of Know Your Customer (KYC) process. On successful activation of this account, one can start investing in a mutual fund. There are two ways of investing in a mutual fund, viz. directly with the AMC (Asset Management Company) or via an authorized intermediary like a banker, broker, etc.
Returns in Fixed Deposit vs Returns in Mutual Funds
Returns in fixed deposits
Fixed deposits, as the name clarifies, come with a seal of guaranteed returns, unless the lender goes bankrupt, something which does not happen often. In any FD scheme, the FD rates are decided at the time of booking the FD and remain the same till the end of FD tenure.
This means that the returns are uniform, be it a cumulative fixed deposit scheme or a non-cumulative one. One can easily predict their returns using tools like an online FD calculator.
Returns in mutual funds
The rate of return is higher in mutual funds than it is in fixed deposits. It is because mutual funds give exposure to market-linked assets like equity and debt funds. Whereas equity funds are riskier as they are exposed to market fluctuations, debt funds are comparatively safe. Funds in a mutual fund are effectively managed by professional fund managers and they keep on allocating funds where the returns can be optimum. This leads to better returns.
Where equity attracts dividends which are a portion of a company’s profit, debt funds attract guaranteed interest as they are no less than a loan that a depositor gives to the company or government in the form of corporate bonds or government bonds.
Fixed Deposits or Mutual Funds: Which is Better?
Choosing between these two options requires thorough analysis, moreover, understanding of one’s risk-return appetite.
Both the instruments serve a different purpose and it will not be wise to put one above the other. Mutual funds come with a good mix of risk-return while FDs help strike the right balance in one’s portfolio since these do not have any significant risk label attached to them.
Money collected by different investors in a mutual fund is allocated to stock, bonds and other securities. Each mutual fund has a specific objective like limiting the risk of short term investment like 1 year or maximizing returns for a longer-term, say 5 years.
For example, in a target-date fund, say 30 years from now, funds are mostly concentrated to stocks where expected returns are higher and investors can bear higher risk since they don’t need money as of now. This way, returns are maximised before the maturity period nears and when the maturity date appears closer, funds are shifted to safer and conservative options like government bonds.
With fixed deposits, there is no such case. It’s a fairly simple investment vehicle that runs on a fixed rate of interest and does not fluctuate over time. Bank deposits come loaded with insurance cover of Rs. 5 lakh by Deposit Insurance and Credit Guarantee Corporation (DICGC) which is a subsidiary of the Reserve Bank of India or RBI.
Therefore, while mutual funds excel in terms of profits, fixed deposits make their mark where safety is concerned. Thus, make sure to check your risk-tolerance when going for mutual funds and check how much liquidity you can do without when booking an FD.
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