Know Why You Should Choose Mutual Funds Over Fixed Deposits

Fixed deposits are considered to be the safest investment choices available. For generations, FDs were the go-to investment product for many individuals. However, rising inflation, lower returns, liquidity and other factors have made investors think about alternative investment options to FDs. One of the most popular alternatives to FDs is mutual funds.

The following are reasons why you should choose mutual funds over fixed deposits.

Returns

Fixed deposits offer a predetermined interest rate over a predetermined time period. This means that a fixed deposit will only generate a defined amount of returns over a specified time period.

On the other hand, mutual funds invest across equity and debt instruments. Thus, the mutual fund portfolio is exposed to market volatility. Hence, mutual fund investments have the potential to generate substantially higher returns, given the performance of the portfolio’s equities is totally dependent on market conditions.

Risk

Fixed deposits are virtually risk-free investments since investors know in advance what their returns will be over time. Since the interest rate on fixed deposits does not fluctuate and is not subject to market fluctuations or volatility, investors have assured a fixed rate of return. Mutual funds, on the other hand, are sensitive to market fluctuations. However, since the funds invest in a basket of securities, the risk is spread out. Thus, you can gain more if market conditions are favorable.

Liquidity

As the name suggests, the tenure for fixed deposits is fixed, making it difficult to liquidate the investments prematurely. You must pay the penalty if you want to redeem a Fixed Deposit before its maturity date. Furthermore, the interest rate will also be lower on your deposits.

In contrast, mutual funds are extremely liquid. The fund units can be redeemed at any time with a few clicks of the mouse, and the funds will be transferred to the linked bank account within two to three business days.

Investment Amount

A fixed deposit requires you to invest a lump sum amount in one go. Often, this may be difficult for many investors. On the other hand, you can invest in mutual funds with as little as INR 1,000. Systematic Investment Plans (SIPs) in mutual funds allow you to invest a fixed amount regularly. Thus, mutual funds are suitable for all types of investors. You can start building a corpus by investing a small amount regularly over time.

Costs

Mutual fund investments incur expenses in the form of fees paid to fund managers who oversee an investor’s portfolio. On the other hand, individuals who invest in fixed deposits do not have these costs because there is no fund management and distribution activity involved. However, compared to the high returns mutual funds are able to generate for investors, the associated costs are almost negligible.

Premature Withdrawals

You will likely incur a penalty if you wish to make premature withdrawals from their fixed deposits. In addition to the imposed penalty, the individual would also lose a percentage of the anticipated returns.

On the other hand, there is no lock-in period for mutual funds (except for ELSS funds). However, for some mutual funds, an exit load of 1% of the fund’s value will be levied if a withdrawal occurs one year from the date of investment.

Taxation

In terms of taxation, capital gains from equity funds and hybrid funds will be considered short-term if their holding period is less than 12 months and long-term if it exceeds 12 months. A holding duration of less than 36 months for debt funds is considered short-term. Whereas a holding period of 36 months or more is considered long-term. Long-term capital gains on equity mutual funds and hybrid mutual funds exceeding INR 1 lakh would be taxed at 10%, while short-term capital gains would be taxed at 15%. Long-term capital gains for debt funds will be taxed at 20% after indexation, whereas short-term capital gains will be taxed according to the tax bracket. The interest income is taxable based on your tax bracket in the case of fixed deposits.

Impact of Inflation

The returns from fixed deposits are fixed. Post-tax returns after adjusting for inflation can sometimes be almost nothing on maturity. Since returns from FDs are lower, and with high inflation, the actual returns are almost negligible. On the other hand, mutual funds have given higher inflation-adjusted returns. Mutual funds invest across securities that have the capacity to generate higher returns in the long term. Thus, the overall returns from mutual funds after adjusting for inflation can still be significant.