Beginning your investment journey? Experts provide clarity on FDs vs Mutual Funds

FDs vs Mutual Funds: Wondering whether to stick with Fixed Deposits (FDs) or take the plunge into Mutual Funds? Choosing between these two investment avenues can be daunting, especially for novice investors. Financial experts offer valuable insights into the comparative merits and risks of FDs and Mutual Funds.

"In navigating the FD vs Mutual Funds conundrum, investors must align their choices with their financial goals and risk appetite. While FDs offer a sense of security with assured returns, Mutual Funds present opportunities for potentially higher returns albeit with market risks. In an environment of dwindling interest rates, Mutual Funds, particularly Debt Funds with their tax advantages, emerge as compelling options for investors seeking to optimise their investment portfolios," said Agam Gupta, Executive Director, Share India Fincap.

What is FD?

Fixed Deposits, as the name implies, offer investors a fixed interest rate for predetermined tenures, typically ranging from 7 days to 10 years. These deposits provide a sense of security with assured returns and capital protection upon maturity. However, the landscape for FD investors has shifted notably, with the specter of declining interest rates casting a shadow over their once-attractive yields. “The COVID-19 pandemic prompted aggressive rate cuts by the Reserve Bank of India (RBI), leading to a corresponding reduction in FD interest rates. Consequently, FD interest rates have dwindled to levels where, on a post-tax basis, they struggle to outpace inflation, posing a challenge especially for senior citizens reliant on FDs for income,” Gupta added.

What are Mutual Funds?

In contrast to the fixed returns of FDs, Mutual Funds represent a diversified investment vehicle that pools money from multiple investors to invest in a portfolio of stocks, bonds, or other securities. These funds, managed by Asset Management Companies, offer a spectrum of investment options tailored to investors' financial objectives. Equity Mutual Funds primarily target capital appreciation, while Debt Funds aim to generate income through investments in money and bond markets.

“One of the key advantages of Mutual Funds over FDs lies in their tax efficiency. Equity Mutual Funds enjoy favorable tax treatment, with long-term capital gains (held for more than 12 months) taxed at 10 per cent after the initial exemption of up to Rs 1 lakh. Similarly, Debt Funds offer tax benefits through indexation, where long-term capital gains (held for more than 36 months) are taxed at 20 per cent after factoring in inflation,”Gupta added.

Key differences analysed

A comparative analysis reveals nuanced distinctions between FDs and Mutual Funds across various parameters:

Safety

FDs are traditionally perceived as very safe investments, contingent upon the financial stability of the bank or financial institution. In contrast, Mutual Funds carry market risks, with different schemes exhibiting varying risk profiles.

Liquidity

While FDs offer medium to high liquidity with penalties for premature withdrawals, Mutual Funds, particularly open-ended ones, provide high liquidity albeit with potential exit loads.

Returns

FDs offer assured returns, whereas Mutual Fund returns are market-linked. Historical performance data indicates strong returns for top-performing funds across categories.

Taxation

FD interest is taxed as per the depositor's income tax slab, whereas Mutual Funds offer tax advantages, especially in the case of long-term capital gains taxation, where indexation benefits apply.

Investor interest protection

FDs are regulated by the RBI, ensuring a level of depositor protection, while Mutual Funds fall under the regulatory purview of the Securities and Exchange Board of India (SEBI).