I have came across a lot of people in my life who would very happily opt for fixed deposits when it comes to saving money. Their main reason of going for fixed deposits are no risk involved and safety of money in banks. But have you ever thought, by keeping your money in banks, are you actually saving it or losing it? So, today I am going to compare Mutual Funds and Fixed Deposits on the basis of certain parameters.
Safety: Well, almost all the Fixed Deposits are AAA rated which means very high safety of capital. So, in case of FD’s, the chances of losing money is very very low. But always keep in mind that FDs only to the extent of Rs 1 Lakh are guaranteed by the government. For FD’s higher than that value, the credit rating of bank comes into play and which bank you choose plays an important role.
When it comes to Debt funds, they are not themselves rated but their safety can be deduced from the portfolio they invest in which is typically sovereign to AA. With careful analysis, you can pick debt funds whose portfolio has a combined credit risk almost at par with FDs.
Returns: Fixed deposits offer assured returns. When you go for a FD, the interest rate gets locked. And interest rate is 8 to 9% for FDs above a year. You can accurately predict the amount of money you will have at the time of maturity even before you start the FD. FD may give attractive returns on paper, but with the tax payable at the current tax slab, the more one invests in FDs, the more tax one has to pay. Taking in consideration the rate of inflation over the years, it is possible that one may actually be facing a loss by investing in FDs.
When it comes to Debt funds, they give 8-9% returns when you look at the historical debt funds’ performance. However, returns for debt funds are not guaranteed. While debt funds are mostly safe investments, there could be some volatility due to the fluctuations in interest rates. Some debt funds react more to these fluctuations than others and once again, with careful analysis, you can pick those with low volatility. Although MFs are affected by market volatility and do have a level of risk, they are managed by professional fund managers, who do their best not only to protect investments but also to grow it.
When it comes to rate of returns, FD rates are pre-specified and do not change for the entire tenure. On the other hand MF rates are affected by market conditions, hence during positive market conditions; MFs have the potential to earn high returns where as FD rates are unaffected.
In terms of risk, FDs are generally known for minimal risk, where as equity mutual funds carry high market risk, and debt mutual funds carry lower market risk than equity. But risks can be mitigated to a certain extent as MFs are managed by professionals. Yet, MFS are prone to market risk. But as it is said, big risks give big returns. FDs have a fixed time period as the name suggests, and generally have low liquidity till the tenure of the deposit ends. In case of MFs, most of them offer high liquidity on the condition that the minimum holding period has passed and subject to lock-in period as applicable. In case of premature withdrawals, FD holders have to pay a penalty, and miss out on a portion of the expected returns. MFs only charge an exit load if investments are withdrawn, in a very short period, normally under a year. Some MF Schemes offer high liquidity. Funds can be withdrawn at any given point of time, without any exit load or extra charges. A crucial factor to be considered before choosing between FDs and MFs should be the tax status. When it comes to FDs, tax levied depends on your current tax slab, irrespective of the tenure of the fixed deposit. Instead the tax status of MFs depends on its category. Equity funds held for long term (more than a year) are not taxable. Short term equity funds are taxable at 15%. Long term debt fund gains are taxable at 20% with indexation and 10% without indexation and short term capital gains are taxable according to investor’s tax slab. Hence we can say that MFs are tax friendly compared to FDs. Especially gains on long term equity funds, which are not taxable at all. In the end, the decision to invest between a FD and a MF is based on the risk capacity, and the horizon of the individual. But when the things are hopeful, and there are good prospects for growth of the economy, it makes greater sense to invest in MF, because of the possibility of returns.