Investments that you make should be in sync with your future financial goals and clearly laid down objectives. Fixed income avenues such as bank fixed deposits or FDs have been trusted by several generations of Indian citizens. The whole concept remains popular since the money stays absolutely secure in the bank while there are guaranteed returns. However, in the current scenario, FD returns after taxes barely manage to surpass inflation. Should you not consider investing in mutual funds instead?
Mutual Funds Vs FD - A Thorough comparison
- Returns- The aspect that works for bank FDs is the concept of assured or guaranteed returns. You will get to know the amount that you will garner by way of returns at the time of investment. Various banks have diverse returns offered on money that is invested for varied timelines. This means that if a specific amount of money is deployed in a bank fixed deposit for a period of 3 months, the rate of interest may be lower than that of a 12 month fixed deposit. However, the bank will guarantee payment of interest rate at maturity that was promised at the time of investment.
- For mutual funds, however, there are no assurances of fixed returns. The return amount may fluctuate based upon market movements. This does not mean that returns will always go downwards. In the long haul, chances are more for getting superior returns if you stay invested. Investing for shorter durations between 1-3 years means that debt funds are a good option. The returns for debt mutual funds usually hover between 6-9% while bank FD rates may be slightly lower at 6-8%. If 1-year liquid funds are considered, their return rates are superior to regular FDs. They have zero lock-in periods and you can redeem your money on the 7th day without paying any penalties as well.
- Liquidity Levels- Mutual funds have much better levels of liquidity. The units may be redeemed easily at any time you wish. You only have to press a few buttons for this purpose and the money will be deposited into the bank account by 2-3 business days itself. For many debt funds, there are no exit loads charged upon encashment as well. However, if you are thinking of redeeming your FD prior to maturity, a penalty will have to be paid. This is 0.5-1% of the overall amount in SBI for instance.
- Taxation Aspects- Bank FD interest will be taxed in your hands and based upon your final income slab. You will have to pay 20% taxes on FD generated returns if you fall under the 20% income category. This will be 30% if you fall in that particular tax slab. For mutual funds, you will have to pay LTCG (long-term capital gains) on debt funds post 3 years of investments. You will have to pay taxes of 20% although you will receive indexation benefits. This is direct tax relief provided to investors by the Government. Short term gains from funds (less than 3 years) will be added to the annual income of the investor and taxed likewise.
- Risk Levels- FDs offer guaranteed returns. In case of any bank defaults which are a rare scenario, you will receive solely the amount which has been insured, which is up to Rs. 5 lakh. Even if you have deployed Rs. 10 lakh, you will receive Rs. 5 lakh as per the insurance criteria for depositors. There are no guarantees for the minimum return amount on debt mutual funds. Losses are possible only when an investor redeems money on the basis of specific market movements.
- Expenses - Mutual Funds generally have certain charges and expenses which are deducted as a part of managing the fund by the fund house. On the other hand, FDs do not have extra expenses on them; you just have to lock in a fixed amount for certain tenure.
- Withdrawal - Funds can be withdrawn from a mutual fund free of charge but only after a given point of time. If someone decided to withdraw before the stated time, charges levied will be that of 1% in the form of exit load. In the case of fixed deposits, depositors who want to make a withdrawal must break their FD and pay the premature withdrawal penalty for the same.
On a closing note
The core take-away is that you should not put all your eggs in one basket, i.e. only in FDs. Have some FDs for meeting long-term targets and balancing out risks in your portfolio while deploying some portion of the investment corpus towards investing in mutual funds alongside. In the long run, they offer better tax efficiency, liquidity and superior inflation-beating returns as compared to bank fixed deposits (FDs).
This is one strategy that you should employ after consultation with your financial advisor or market expert regarding the same. Investments should be spread out in multiple asset classes which have the potential to earn superior returns while balancing out risks simultaneously.