FIXED DEPOSIT vs MUTUAL FUND
Fixed deposit and Mutual funds are financial instruments used for investing. They are both very popular modes of investment among investors for meeting their financial goals & requirements. The fixed deposit is a traditional form of investment offering a fixed rate of return which is specified at the time of the investment. On the other hand, mutual funds are a pooled investment vehicle making investments in different securities like equity, debt, gold, etc. The rate of return in mutual funds is not fixed as the returns are linked to the performance of securities in the market. Both instruments provide a good return over a period of time and can be opted for by investors as per their risk profile and financial goals. In this article, we do a detailed review of both the investments and also list down the differences between them. Also, you will find the suitability of these investments for different kinds of investors. Let’s have a look.
What is a Fixed Deposit?
Fixed deposits are offered by banks, NBFCs, post offices & other financial institutions. It is a great and traditional way of investing as it helps to grow the savings with a good fixed rate of interest with utmost safety. The tenure of a fixed deposit can be chosen as per your convenience. At maturity, you get the principal/invested amount along with the interest. The interest payout frequency i.e monthly, semi-annual, annual can be opted as per requirements. FDs can be prematurely withdrawn subject to the applicable penalty.
What is a Mutual fund?
Mutual funds are a popular way of investing nowadays. Mutual funds are formed by the asset management company (AMC) or fund houses. They pool the money from different investors and then they invest it in equity,debt-related, or other marketable securities to generate returns for investors. The returns on mutual fund investments depend on the return generated by the fund manager or the AMC from their investments. Investors can choose to invest in different mutual fund schemes as per their risk profile, investment horizon, financial goals & requirements.
Difference between FDs and Mutual Funds
1. Returns:
The one very good thing about fixed deposits is that they offer a fixed and guaranteed rate of interest. The interest rates vary from bank to bank depending upon the tenure. However, it offers a fixed rate of interest throughout the tenure.
While in the case of mutual funds, there is no guarantee of returns and the returns may move up and down as per the condition of the market in which the amount is invested. But the important fact is that mutual funds have the potential to generate higher returns than FDs.
2. Risk:
The fixed deposit generally has a low risk associated with them as they offer a fixed rate of interest. Not all FDs can be considered safe for investments as some FDs with corporates or institutions having low credit ratings might default on payments.
The chances of defaults in banks are generally very low. However, in the case of default by Banks, DICGC (Deposit Insurance and Credit Guarantee Corporation) offers an insurance coverage of up to ₹5 lakh, depending upon the amount of investment. For example, if someone has a fixed deposit amount less than ₹5lakh, then they will get the amount insured equivalent to the FD amount, but if someone has the FD amount more than ₹5lakh, then they will only get ₹5lakh in coverage in case of any default event.
The risks in mutual funds depend upon the type of scheme chosen for investment. Generally, the risks are lower in debt funds as compared to equity-oriented funds.
3. Tenure:
In a fixed deposit, investors choose the tenure at the time of opening the FD account. The tenure can vary from 7 days to 10 years and also it can be renewed after maturity for more duration. An investor can choose the tenure as per their financial goals & requirements.
In Mutual funds, there is no fixed tenure and investors can invest in different funds as per their convenience and financial goals.
4. Liquidity:
Mutual funds are more liquid than fixed deposits. The units of mutual funds can be redeemed anytime with few clicks of buttons and the amount will be deposited in the given bank account within two to three working days.
Fixed deposits are also liquid but as we know there is a fixed tenure for an FD so the investor would have to pay the applicable penalty in case of prematurely withdrawing an FD. The penalty can be 0.5% to 1% on the total amount of fixed deposit as per the rate specified by the bank.
5. Taxation:
Interest earned on the fixed deposit is taxed as per the income tax slab rate applicable to the investor. Interest income on fixed deposits is subject to 10% TDS. The TDS gets deducted if the interest earned exceeds ₹40,000 in a financial year.
While for equity mutual funds, if the units are sold after 12 months, tax is applicable as per the LTCG of 10% if the gains exceed ₹1 lakh per financial year and if the units are sold within the 12 months period, STCG tax of 15% is applicable. For Debt mutual funds, if the units are sold within the period of 36 months, STCG is applicable as per the income tax slab rate of the investor and if the units are sold after the period of 36 months, LTCG tax is applicable at the rate of 20% after indexation benefits.
Comparison between FDs and Mutual Funds
| Fixed Deposits | Mutual Funds | |
| Returns | Have a fixed rate of interest and guarantee returns over a specified period. | Do not have a fixed rate of return as the returns are linked to the market. |
| Risks | FDs generally have low risk and investors are offered a fixed rate of return. | Risks in mutual funds depend upon the objective & category of the scheme. They vary from low to high as per the objective of the scheme. |
| Tenure | Investors can choose the tenure as per their convenience. Also, after maturity, it can be renewed. | Mutual funds generally do not have any fixed tenure, investors can invest in them as per their convenience without any fixed tenure. However, in the case of ELSS funds, they come with a lock-in period. |
| Expenses | FDs do not have any expense ratio. | Mutual funds have an expense ratio for the fund management. It varies across schemes. |
| Withdrawal | FD can be prematurely withdrawn by paying the applicable penalty. | A mutual fund can be withdrawn any time but there can be an exit load in case withdrawal is made within a specified period. |
| Taxation | Interest on FDs is taxed as per the income tax slab rate. They are subject to 10% TDS on interest earned above ₹40,000 in a financial year. | Equity Mutual funds are subject to STCG of 15% and LTCG of 10% if gains exceed ₹1 lakh per financial year. As for debt mutual funds, STCG is as per the income tax slab and the LTCG tax rate is 20% after indexation benefits. |
| Liquidity | FD is less liquid as we get the money only at the maturity of FD. Or before the maturity by paying the applicable penalty. | Mutual funds are more liquid than FD, as we can withdraw investments with a few clicks. |
Benefits of Fixed Deposits and Mutual funds:
- Mutual funds generally do not have any lock-in periods and you can exit whenever you want. For Fixed deposits, investors need to choose a specific tenure as per their goals & requirements where they would be offered a fixed rate of return.
- It is always advisable to invest for longer periods in equity mutual funds as they have the potential to offer good returns over time. If you invest for a short period, there is a possibility of experiencing volatility.
- For shorter time period investments, investors can consider investing in FDs. However, within mutual funds also there are certain categories such as liquid or money market funds that can be selected. These provide higher returns than savings accounts along with a much higher level of liquidity.
- One of the benefits of investing in mutual funds is their offering of tax-efficient returns. In equity mutual funds, LTCG tax at the rate of 10% is applicable only on the gains above Rs.1 lakh in a financial year. And STCG at the rate of 15% is applicable to the gains while selling units within 1 year. In the case of debt funds, an LTCG tax rate of 20% after indexation benefits is applicable to the gains on selling units after 3 years. However, the gains on units sold within 3 years is taxable as per the slab rate applicable to an individual. Whereas, the interest on FDs of any tenure is taxable as per the slab rate of the investor. So, investments in mutual funds can offer tax-efficient returns than FDs.
Conclusion:
So, we can conclude that mutual funds generally have an investment advantage over fixed deposits. While choosing the correct mutual fund to invest in, an investor needs to consider their age, risk profile, investment horizon, financial requirements and other important factors. For the senior citizens, who might consider putting a large sum in bank or corporate FDs, should look at the option of investing in mutual funds that can offer safe and steady returns. Such withdrawals could be made by way of SWPs, which are tax-efficient and can be a regular source of income. For the middle-aged population with a moderate risk profile, it would be good to consider balanced advantage or other hybrid mutual funds as per their financial needs & goals. The ones with a conservative risk profile can look into putting their money in low-risk debt mutual fund categories.
The younger people can consider investments in mutual funds, equity and debt as well depending upon their investment horizon & risk profile as they can generate better returns than FD.
Frequently Asked Questions:
1. Does FD and Mutual Fund offer tax benefits?
Yes, if you invest in FD for a period of 5 years or more, it gives a tax deduction of ₹1.5 lakh per financial year under Section 80C of the Income Tax Act,1961.
And in the case of mutual funds, only the ELSS funds also known as tax saver funds offer the benefit of claiming tax deductions on investments. Also, they come with a lock-in period of 3 years.
2. What is the interest rate offered on FDs?
Fixed deposits can offer interest rates in the range of 3-7.5% p.a. depending upon the offering bank or financial institution. The interest rates also vary across the tenure of deposits.
3. Do mutual funds also offer any additional benefits for senior citizens?
No, Mutual funds do have any additional benefits on the investments by senior citizens. The benefits of mutual funds are the same for everyone irrespective of their age group.
4. What is the exit load in mutual funds?
Mutual funds impose an exit load or a charge on withdrawals by investors. The charges vary from fund to fund. This charge is only applicable if the units are withdrawn within the specified holding period stated by the scheme. In some cases, the exit load is Nil and therefore investors can withdraw at any time without having to bear any costs.
5. How is interest on fixed deposits taxed?
Interest earned on the fixed deposit is taxed as per the income tax slab of the investor. Also, the interest on fixed deposit is subject to TDS of 10% if the interest earned exceeds ₹40,000 in a financial year.
6. How are the gains on equity mutual funds taxed?
The gains on the equity mutual funds are taxed as per the applicable LTCG and STCG tax rates. If the units are sold within the 12 months period, then the gains are taxed with an STCG tax of 15%. If the units are sold after the period of 12 months, then the gains are treated as LTCGs which are taxed at the rate of 10% on the gains exceeding ₹1 lakh per financial year.
7. How are the gains on debt mutual funds taxed?
The gains on the debt mutual funds are taxed as per the applicable LTCG and STCG tax rates. If the units are sold within the 36 months period, then the gains are treated as STCG (Short Term Capital Gains) which is applicable as per the income tax slab of the investor. If the units are sold after the period of 36 months, then the gains are treated as LTCG (Long Term Capital Gains) which are taxed at the rate of 20% after the benefits of indexation.
8. How can I invest in mutual funds?
You can simply download and login to the ZFunds App to start investing in mutual funds for free.