Fixed Deposits vs Debt Mutual Funds: A Comparative Analysis

Debt mutual funds are relatively recent investment options introduced in the Indian market. This 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 according to 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 and some retirees may prefer parking their money under debt mutual funds rather than fixed deposits. These funds offer investors marginally better returns once the scheme matures.

A fixed deposit (FD) is a type of financial instrument made available by banks or NBFCs that allows 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.

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.

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

• 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, enabling you to 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 over 3 years, your Long Term Capital Gains will be taxed at 20%. In addition, you also have the benefit of indexed acquisition costs. 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.

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

• Risk Factors: Investors should know all the risks accompanying investments in such funds. There are three main 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 returns because the returns are based on prevalent market conditions. However, if you observe the past performance of such funds before investing, you may invest 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 financial goals.
• Time Horizon: Debt funds can be invested for short, medium and long-term durations. You should choose the debt funds based on your liquidity requirements and investment objectives.

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 better than debt mutual funds because they carry almost no risk. Even if a bank somehow defaults, which is less likely, deposits of up to Rs. 5 lakh are covered by DICGC insurance. Further, this insurance coverage 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.

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 the fixed deposits various banks and other financial institutions offer.
• Check if any bank is providing Flexibility in FD Tenure.
• Choose a fixed deposit that meets your needs rather than one that is popular or that other people are investing in.
• 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%.

The above information can help you decide whether to invest in debt mutual funds 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 than fixed deposits. On the other hand, fixed deposits yield low returns. Consider these factors to make an informed decision.