Debt Mutual Funds vs Fixed Deposit (FD) Know the Difference: Which is Better for You?

10 min read • Updated 26 September 2023
Written by Anshul Gupta
Debt Mutual Funds are better than Fixed Deposits

Investors approaching retirement often seek avenues to invest a substantial corpus to ensure safe and steady returns, aiming for financial security in their non-earning years. Historically, bank Fixed Deposits (FDs) have stood out as a favoured choice, given their safety and predictability. However, a growing perspective among experts is that debt mutual funds have an edge over FDs, primarily due to their potential for slightly higher returns.

These investment options are predominantly targeted towards investors with a low-risk tolerance, seeking to preserve capital while earning a steady income. The comparison between FDs and debt mutual funds becomes crucial as it could significantly impact post-retirement financial well-being. Evaluating each option’s nuances, benefits, and potential drawbacks is essential for making an informed decision that aligns with individual financial goals, risk capacity, and liquidity needs.

What Is a Debt Fund?

Debt mutual funds are relatively recent investment options introduced in the Indian market. This type of mutual fund invests most of its corpus in debt securities such as government and corporate bonds, treasury bills, money market instruments, and more. All of these are fixed-income instruments that come with a pre-decided interest rate and maturity date.

In debt mutual funds, the capital from multiple investors is gathered together and the fund manager invests it in various fixed income instruments as per the scheme objective. According to historical data, debt mutual funds are less risky than equity or hybrid mutual funds.

Young individuals who have just started investing, as well as some retirees, may prefer parking their money under debt mutual funds rather than fixed deposits. This is because these funds tend to offer investors marginally better returns once the scheme matures.

What Are the Benefits of Investing in Debt Funds?

Based on risk tolerance and other factors, the benefits of debt mutual funds are stated below:

  • Debt funds offer stable returns with a low risk of losses. Their returns are predictable even during periods of high market volatility.
  • Debt mutual funds have high liquidity which enables you to easily withdraw your money at any time in the future.
  • People who invest in debt mutual funds are eligible for certain tax-saving benefits. If you hold any debt mutual fund for more than 3 years, your Long Term Capital Gains will be taxed at 20%. In addition to this, you also have the benefit of indexed cost of acquisition. Based on the past data, the gains on debt funds held for over 3 years virtually end up tax free.
  • If you invest in low risk funds, you will not have to worry about locking your money under the scheme for a certain period. 
  • Debt funds also help people diversify their investment portfolios. 

Factors to Consider before Investing in Debt Funds

Below are certain things that investors should keep in mind before they invest in debt mutual funds:

  • Risk factors- Investors should be aware of all the risks accompanying investments in such funds. There are mainly three types of risks to consider- credit risk, liquidity risk and interest risk. Debt funds carry relatively low credit risks but are not entirely free from interest rate risks.
  • Expected returns: Like any mutual fund, debt funds do not guarantee any returns because the returns are based on prevalent market conditions. Although if you observe the past performance of such funds before investing, there is a chance that you will end up investing in a well-performing fund.
  • Investment objective: Sometimes, people invest in debt funds because they want a secondary or another source of income that can supplement their primary source of income. As an investor, you need to decide whether you are willing to pick an investment with risks if your goal is to create a secondary income source. You should invest in a debt scheme if its objectives align with your own objectives.
  • Time horizon-  Debt funds can be invested for any of the short, medium and long term durations. You should choose the debt funds based on your liquidity requirements and investment objectives.

What Are Fixed Deposits?

A fixed deposit (FD) is a type of financial instrument made available by banks or NBFCs that allow investors to lock in their money in an FD account of a bank or other financial institution for a certain period. Over this time, the deposit will generate a fixed amount of interest that can be reinvested or paid out monthly, quarterly, or annually.

Banks let investors choose the tenure to deposit their money. For example, you can deposit your cash under fixed deposit accounts from 7 days to 10 years. The higher the deposit year, the more interest you will receive from the banks.  

What Are the Benefits of Investing in Fixed Deposits?

The benefits of depositing your money under fixed deposits are as follows:

  • Even if the market condition fluctuates, the returns from fixed deposits will remain unchanged. That means the interests on fixed deposits are fixed throughout the investment period. 
  • Some investors may consider FDs to be better than debt mutual funds because it carries almost no risk. Even if a bank somehow defaults, which is a less likely event, deposits of up to Rs. 5 lakh are covered by DICGC insurance. Further, this insurance cover limit is bank wide and can be availed if you have FD accounts with different banks. However, if you have multiple FD accounts with the same bank, you’re only eligible for Rs. 5 lakhs across all the FD accounts and not for each FD.

Also Read: Experience financial growth with unmatched Bajaj Finance FD Rates

Things to Consider Before Investing in FDs

Below are certain things that you must keep in mind before you deposit your money under any fixed deposit:

  • Compare and evaluate all the fixed deposits that various banks and other financial institutions currently offer.  
  • Check if any bank is providing Flexibility in FD Tenure. 
  • Choose a fixed deposit that meets your needs and not which is popular or other people are investing. 
  • The DICGC cover on deposits up to Rs. 5 lakhs is only available in case of FDs opened with Banks.
  • Interest earned on fixed deposits is added to your total income and is taxed according to your tax slab. Hence, interest on FD can attract a tax of up to 30%.

Also Read: Tax Saving FD Interest Rates 2023

Comparative Analysis between Debt Funds and Fixed Deposits 

The difference between debt funds and fixed deposits is illustrated in the table below. This will help you understand whether debt mutual funds are better than FD.

FeaturesDebt Mutual Fund Fixed Deposits 
RisksInvestors will have to tolerate nominal risks. FDs carry relatively lower risk. 
ReturnsThe returns are linked to market conditions.  Returns are fixed irrespective of the market conditions
Investment OptionsAs an investor, you will have the option to invest via lump sum or SIP. You will have to invest the entire corpus at one time. 
LiquidityPeople prefer to invest in debt mutual funds because they have high liquidity. Fixed deposits can also be withdrawn prematurely, however banks may charge a penalty fee. 
Withdrawal Debt funds generally don’t carry exit load except in a few cases, so you don’t always have to pay withdrawal chargesWhen you withdraw your money prematurely, you will have to pay a certain penalty to the bank. 
Investment expenditure Investors have to incur fund management charges as per the expense ratio of the scheme.There are no management charges involved in fixed deposits. 

Tax Rules for Debt Funds vs. FD

Taxation has a crucial role in all investments of a financial nature. Here’s how the tax rules affect Debt funds in contrast to Fixed Deposits:

Debt Funds:

STCG: STCG stands for ‘Short Term Capital Gains’. If your debt funds have been sold within three years of investment, then they are considered as Short-Term Gains and are taxed according to the individual’s income tax slabs.

LTCG: LTCG stands for ‘Long Term Capital Gains’. If your debt funds are sold any longer than three years of investment, they are considered Long Term Gains and any profit you make is taxed at 20%. There’s also an indexation benefit, which adjusts the buying cost for inflation and can lower the amount of profit that gets taxed.

Income of a Dividend nature: Dividend gains from your Debt funds are added to your overall income and then taxed accordingly to the slab rate that you belong to.

Fixed Deposits:

Taxing the Interest from Income: The interest accrued from Fixed deposits is added to your overall income and taxed according to your tax slab.

TDS: TDS, or Tax Deducted at Source, occurs when your interest income exceeds an aforementioned threshold. However, if you do not qualify for TDS, you should submit form 15G or 15H, depending on whether you are a regular adult or a senior citizen.

Lack of LTCG Benefits: Unlike Debt funds, FDs do not have an LTCG benefit. The gains from FDs are taxed according to the individual’s tax slab rate.

How Indexation Helps Reduce Tax Liability of Debt Funds

Indexation helps you pay less tax on the profits from debt funds by considering the impact of inflation. Here’s how it works in simpler terms:

  1. Adjusting Purchase Price: Indexation increases the original cost of your debt fund units by factoring in inflation, measured by the Consumer Price Index (CPI).
  2. Higher Adjusted Cost: This process results in a higher adjusted cost of your investment, meaning the “new” cost is more than what you originally paid.
  3. Smaller Profit: When you sell your investment, your profit is calculated as the difference between the selling price and the adjusted (higher) cost. So, your profit appears smaller due to indexation.
  4. Less Tax Paid: Because your profit is now smaller, the tax you need to pay on it, at the rate of 20%, is also less, helping you save money.

Final Word

The above-mentioned information can help you to decide whether to invest in debt mutual  or FD. Before investing, ensure that you understand your risk appetite and investment goals. Many debt funds have low risks and give optimal returns but are less safe compared to fixed deposits. On the other hand, fixed deposits are not that high yielding in terms of returns. Consider these factors to make an informed decision.

Frequently Asked Questions

1. Who should invest in debt mutual funds?

Ans: The following kinds of people can choose to invest in debt mutual funds:

  • Investors with tenure above 3 years can prefer debt funds due to taxation advantage
  • People who are retiring soon, retirees, and beginner investors.
  • Risk averse investors can choose debt funds.
  • Investors who wish to diversify their portfolio.

2. Who should invest in fixed deposits?

Fixed deposits are a suitable investment for the following types of people, and they can deposit their money if they wish to:

  • Individuals who are unwilling to incur any kind of market-related risks. 
  • People who want a stable and regular income every month. 
  • Individuals with spare cash, especially housekeepers, choose to deposit their money under bank FDs. 

3. What are the different types of debt funds?

The different types of debt funds in which one can invest are as follows:

  • Corporate bond fund
  • Dynamic bond fund
  • Money market fund
  • Credit risk fund
  • Liquid funds
  • Gilt funds
  • Floater funds
  • Ultra-short duration fund 
  • Low duration fund
  • Short duration fund
  • Medium duration fund
  • Long duration fund
  • Fixed Maturity Plans
  • Medium to long-duration fund 
  • Gilt funds with 10-year constant duration
  • Overnight Funds

4. What are the different types of fixed deposits?

Individuals can choose to deposit their money under the following kinds of fixed deposits:

  • Regular FD
  • Tax saving FD
  • Bank deposits
  • Company deposits 
  • Cumulative fixed deposit
  • Non-cumulative fixed deposit
  • Senior citizen FD
  • NRI FD

  • What is a good long term investment, FD or Debt Funds?
  • Whether FDs or Debt Funds are a better long-term investment depends on individual risk tolerance, investment goals, and tax considerations; Debt Funds can offer potential tax benefits and slightly higher returns, but FDs provide safety and predictability.
  • Which can provide greater profits: FD or Debt Mutual Funds?
  • Generally, Debt Mutual Funds have the potential to offer greater profits than FDs due to the possibility of higher returns and favorable tax treatment, especially with indexation benefits for long-term investments.

Was this helpful?

Anshul Gupta

Co-Founder
IIT Roorkee Alumnus and CFA with experience of structuring debt products worth more than 15000Cr for institutional and retail investors.

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