Indian investors have always had a preference towards bank fixed deposits, considering there were very limited safe investment options available back in the day. Today, with an influx of various investment options, especially the likes of mutual funds, investors often contemplate whether to stay invested in bank FDs or explore other investment avenues. Mutual funds, with different varieties catering to different investor risk appetites, remain the next most preferred option.
As post-tax FD returns struggle to beat inflation, the question is, are these worth considering for investors? Should they instead opt for mutual funds? What does investing in each mean for investors? Let’s understand the differences between these two investment options and understand which one makes for a worthy investment.
What are fixed deposits?
FDs of fixed deposits offer a fixed interest rate on investment for fixed tenures. The tenures in this form of investment can be anywhere from 7 days to 10 years. Bank FDs offer compounded interest, i.e. interest on the accrued interest.
To understand this with an example: Let’s say a bank pays 6% interest (compounding annually) on a 3 year FD. If an investor invests Rs. 100 in it, at the end of 1 year, his investment will have become Rs. 106. In the 2nd year, the investor will earn 6% interest on principal plus the interest already earned, i.e. 6% on Rs. 106 or Rs. 6.4. This is due to compounding.
One of the main concerns among FD investors is the declining interest rates. Trends suggest that these have been declining for the past 2 decades. As the central bank continues to aggressively cut interest rates, especially since the outbreak of Covid-19, FD interest rates have only been on a declining trend. Therefore, the earnings post-tax from these investments can hardly beat inflation. The interest earnings on FDs are subject to income tax as per the investor’s tax slabs. There is also no indexation benefit to be availed from FDs.
Mutual funds are managed by Asset Management Companies that pool investor money to further set up investment portfolios consisting of various investment instruments, including stocks, bonds, government securities, etc. There are a variety of investment avenues available within mutual funds, and investors can select funds that best suit their risk/return appetite and investment time horizon, among other factors. Most mutual funds aim to achieve capital appreciation, combined with steady income flow for investors.
AMCs appoint fund managers to manage mutual funds and these managers are responsible for various decision-making aspects like portfolio composition, shuffling of instruments, etc. In return for managing funds on behalf of investors, fund managers charge a certain percentage of the total earnings as fees. Thus, investors must pay an expense ratio associated with the mutual fund.
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How are FDs different from mutual fund investment?
Here are a few differentiating factors between FDs and mutual funds that will help investors in making informed investment decisions:
|Risk||Relatively low risk depending on bank standing.||Mutual funds involve market risks. Depending on the type of schemes chosen, the risk exposure could differ.|
|Liquidity||Low liquidity since there are penalties on premature withdrawals from most FDs||Open-ended funds offer higher liquidity. Withdrawals may attract exit load if made within a certain period from the date of investment|
|Assurance of returns||Guaranteed returns||Returns are market linked and there is no guarantee of returns.|
|Taxation||As per income tax slab of investors||Short term capital gains tax is applied as per income tax slab of investors. Long term capital gains tax can fetch indexation benefits in debt funds.|
FD versus mutual funds – where to invest?
In the debate on safety of investment, FDs are always preferred over mutual funds. These offer assured interest earnings and capital protection. Along with this aspect, investors must know that FDs offer lower liquidity and the safety of the invested capital also depends on the financial strength of the bank or institution.
While comparing FDs to mutual funds, the latter help in diversifying the overall portfolio through exposure to different securities. However, mutual funds involve market risks and the returns are not assured as compared to FDs. Different mutual funds come with different risk profiles. While equity funds have higher potential to generate positive returns in the long term, they are best suited for investors who have a high risk appetite. Debt funds, on the other hand, are suitable for short to medium-term investment goals and ideal for risk-averse investors.
FDs are one of the safest investment options available, combined with the fact that they also offer one of the lowest return percentages. In contrast, mutual funds are worth exploring since there are many varieties that offer different returns with different risk elements. These cater to a wider investor population, with exposure to various instruments depending on preference and individual investment goals.
1.Can you lose your money in a fixed deposit?
The chances of losing money in a fixed deposit are very low. However, it depends on the financial strength of the bank.
2.How many FDs can I open?
There is no limit on the number of FDs that you can open.
3.Is a debt fund safer than FD?
Debt funds invest in fixed-income securities and these are comparatively safer than equity funds, which mainly invest in stocks. Due to the credit and interest risk involved, debt funds offer lower safety of funds in comparison to FDs.
4.How to invest in mutual funds?
To invest in mutual funds, you can download the Xfinity app that gives access to a wide range of mutual fund categories. Depending on your risk and return appetite, you can invest in a fund of choice through this app.
5.Can I lose all my money in a mutual fund?
Securities that are held in a fund may gain or lose, depending on market movements and other factors. While there are chances of losing money from a mutual fund investment, it depends on the risk level of the fund and past performance.