Fixed Deposits vs Mutual Funds, where to invest your money?

Investing money is an essential step towards achieving financial stability and securing one's future. However, choosing the right investment option can be a daunting task. 

The two most popular investment options in India are fixed deposits and mutual funds. FDs seem to be lucrative when interest rates are on the rise but it is interesting to see if it is true in actuality. This article aims to provide a comprehensive comparison of the two options, highlighting their features, benefits, drawbacks, and suitability for various investment goals.

1. Fixed Deposits : 

Fixed deposits refer to investments made in banks or financial institutions for a fixed period, offering a predetermined interest rate. Fixed Deposits are the traditional investment choice for most Indian families. As per RBI research released in June 2020, more than 50% of the average family's financial assets are invested in Bank Fixed Deposits.

Some key benefits of fixed deposits include:

• Guaranteed returns: Fixed deposits offer a guaranteed return on investment, making it an attractive option for risk-averse investors.
• Low-risk investment: Fixed deposits have a low risk of capital loss as the principal amount invested is secure.
• Stable returns: The interest rate on fixed deposits remains unchanged during the investment period, providing a stable source of income.
• Flexible investment tenure: Fixed deposits offer flexible investment tenures ranging from 7 days to 10 years.
• Easy to understand: Fixed deposits are easy to understand and invest in, making them a popular investment option among first-time investors.

However, there are some drawbacks to investing in fixed deposits, such as:

• Low returns: The returns offered by fixed deposits are generally lower compared to other investment options such as equity.
• No liquidity: Fixed deposits do not offer any liquidity during the investment tenure, and investors cannot withdraw the invested amount before maturity without incurring a penalty.
• Limited potential for capital appreciation: Fixed deposits do not offer any potential for capital appreciation, and the returns are limited to the interest rate offered.
• Taxation: FD interest is taxed as per the income tax slab of depositors. 

2. Mutual Funds: 

A mutual fund is a professionally managed investment vehicle that pools money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other securities. Mutual funds have a long history in India with the setting up of Unit Trust of India in 1963, the popularity of mutual funds among retail investors has grown only in the last 20 years. As per AMFI data, The AUM of the Indian MF Industry has grown from ₹ 8.26 trillion as on January 31, 2013 to ₹39.62 trillion as on January 31, 2023 around 5 fold increase in a span of 10 years. 

Some key benefits of mutual funds include:

• Professional management: Mutual funds are managed by professional fund managers who have expertise in the financial markets, providing investors with a higher chance of earning higher returns.
• Diversification: Mutual funds offer diversification, which means investors can invest in a variety of stocks (from different sectors), government or corporate securities, commodities etc. reducing the risk of capital loss.
• Potential for higher returns: Mutual funds have the potential to generate higher returns & have capabilities to beat inflation.
• Liquidity: Mutual funds offer liquidity, and investors can easily redeem their money as and when required.
• Variety of investment options: Mutual funds offer a variety of investment options such as Equity funds, Debt funds, Hybrid funds, Flexi cap funds, and more, providing investors with options to suit their investment goals and risk appetite.
• Taxation : Short-term capital gains in equity funds (held for less than 1 year) are taxed at 15% and long-term capital gains (held for more than 1 year) of up to Rs 1 lakh is exempted from tax and it taxed at 10% thereafter. In debt funds, short-term capital gains (held for less than 3 years) are taxed as per the income tax slab of the investor and long-term capital gains (held for more than 3 years) are taxed at 20% after allowing indexation benefits. Therefore, in the debt fund vs fixed deposit comparison, debt funds scores high.

However, there are some drawbacks to investing in mutual funds, such as:

• Market risk: Mutual funds are subject to market fluctuations, and investors may incur capital losses in case of a market downturn.
• Management fees: Mutual funds charge management fees which can be seen as an expense ratio.
• Complexity: Mutual funds can be complex to understand, making it challenging for first-time investors to make informed investment decisions.

3. Fixed Deposits vs Mutual Funds:

Fixed deposits and mutual funds differ in several ways. 

Some key differences between the two investment options are:

1. Risk and return comparison: Fixed deposits offer low-risk, low-return investment options. The returns offered by fixed deposits are generally lower compared to other investment options such as mutual funds. On the other hand, mutual funds offer high-risk, high-return investment options. Mutual funds are subject to market fluctuations, and investors may incur capital losses in case of a market downturn. However, mutual funds have the potential to generate higher returns compared to fixed deposits.
2. Liquidity comparison: Fixed deposits have no liquidity during the investment tenure, and investors cannot withdraw the invested amount before maturity without incurring a penalty. On the other hand, mutual funds offer liquidity, and investors can easily withdraw their money as and when required.
3. Taxation Comparison: The interest earned on fixed deposits is taxed as per the investor's income tax slab. In contrast, the taxation on mutual funds depends on the type of mutual fund, holding period, and the investor's income tax slab.

4. Where to Invest Your Money?

Several factors should be considered when choosing between fixed deposits and mutual funds. Some of the factors are as below,

• Risk appetite, Investment Goals, and Investment Horizon: Fixed deposits are suitable for investors looking for a low-risk, fixed-income, and short-term investment options. On the other hand, mutual funds are suitable for investors looking for a moderate or high-risk, high-return, and long-term investment options.
• Capability to Beat Inflation: Fixed deposits offer guaranteed returns, but they may not be able to beat inflation, leading to a loss in the purchasing power of the investor's money. In contrast, mutual funds have the potential to beat inflation and provide higher returns over the long term. 

In conclusion, both fixed deposits and mutual funds have their benefits and drawbacks. The choice between the two investment options depends on the investor's risk appetite, investment goals, investment horizon, and taxation. FDs can be used as short-term investment for an emergency fund, short-term goals etc. while Mutual funds can be used as long-term investments for long-term financial goals where SIP (Systematic Investment Plan) & SWP (Systematic Withdrawal Plan) can be good options to manage those investments.

Investors should carefully evaluate their options before making an investment decision. It is also recommended to seek advice from a financial advisor before investing.