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Debt Mutual Fund vs Fixed Deposit – What Should You Choose?

Learn about the Debt Mutual Fund vs Fixed Deposit and which one to choose for investments and financial planning.

When it comes to investing the debt portion of asset allocation, there is often a "Debt Mutual Fund vs Fixed Deposit" debate in an investor's mind. This article explains the debt mutual funds and fixed deposits, their features and compares the two.

What are fixed deposits?

A fixed deposit is a debt security in which the depositor and the financial institution get into a contract. Then, the depositor invests his/her money for a specified period at a specified interest rate. Open a fixed deposit with a bank, NBFC, or a post office. In an FD, the following components are determined at the start & remain fixed throughout the contract:

  1. Fixed deposit amount
  2. Interest rate payable
  3. Tenure

As evidence of the fixed deposit, the financial institution issues a fixed deposit receipt (FDR) or FD advice to the investor. The FD interest rate is usually compounded quarterly. The investor can choose to receive interest monthly, quarterly, half-yearly, yearly, or maturity. The interest earned on fixed deposits is taxable. It is added to the individual's income and taxed as per his/her tax slab.

The Deposit Insurance and Credit Guarantee Corporation (DICFC) insures every individual's deposits with each bank (private, public, and foreign banks operating in India) for up to Rs. 5,00,000. For Indian investors, fixed deposits are amongst the most favoured investment options, along with gold and real estate.

What are debt mutual funds?

A debt mutual fund invests most of the scheme money in fixed income securities like Government securities, corporate bonds, debentures, commercial papers, and others. The tenure of these securities and the interest rate payable is fixed. Market regulator SEBI has classified debt mutual funds in 16 different categories based on their characteristics. 

This article will focus on liquid mutual funds. They are somewhat closer to bank fixed deposits in terms of comparison. Liquid mutual funds, a type of debt mutual fund, invest in debt securities with a maturity of up to 91 days. These funds aim to provide low to moderate returns to investors along with protecting their capital. In addition, these funds also provide liquidity and ease of access to money.

An investor can invest his/her emergency fund money in a liquid fund. However, while liquid funds invest the scheme money in debt securities with a higher credit rating, they don't provide the insurance cover provided for bank fixed deposits by DICGC.

Taxation of debt funds

  1. Short-term capital gains tax: If an investor holds debt fund units for less than 36 months, the capital gains are classified as short-term capital gains (STCG). The STCG is added to an individual's income and taxed as per the income tax slab.
  2. Long-term capital gains tax: If an investor holds debt fund units for more than 36 months, the capital gains are classified as long-term capital gains (LTCG). The LTCG tax is charged at 20% on the LTCG with indexation benefit.

Returns given by bank fixed deposits and liquid mutual funds.

Diagram 1: Returns given by 1-year fixed deposits


(Source: Capitalmind website)

As can be seen from the above chart, the 1-year fixed deposit rates have been trending down for the last 10 years or so. In 2011, the 1-year fixed deposit interest rate was slightly above 9%. In 2021, most banks are paying around 5% for a 1-year fixed deposit.

Diagram 2: Returns given by liquid mutual funds


(Source: Axis Mutual Funds Website)

The above table shows the performance of Axis Liquid Fund – Regular – Growth Plan. The returns for the direct plan will be a little higher. In the last 1 year, the fund has given a return of around 4%.

Comparison of fixed deposits and debt funds

We have seen the features of fixed deposits and debt funds. Let's compare them.

FeatureFixed depositDebt mutual funds
Nature of returnsPre-decided: The return on FDs is specified at the time of investment. The return remains fixed throughout the tenure of the FD.Market-linked: The return on debt MFs is not specified at the time of investment. The returns during the tenure are market-linked, based on the performance of securities bought by the scheme.
Risk: Safety of capitalWhen investing in a fixed deposit, usually your capital is safe unless the bank itself fails. In that case, also, your deposits of up to Rs. DICGC insures 5,00,000 with the bank.Liquid mutual funds invest in debt securities with high credit ratings. However, you cannot rule out default risks. In such cases, you cannot rule out partial loss of capital as your money is spread across securities of multiple issuers. In addition, there is no insurance cover.
Tax benefit at the time of investmentAn investment in a 5-year tax-saving fixed deposit is eligible for deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed is Rs. 1,50,000 in a financial year. Other fixed deposits are not eligible for tax benefit.An investment is a liquid mutual fund that is not eligible for deduction from taxable income.
Taxation of interest/capital gainThe interest earned on a fixed deposit is taxable. The interest is added to the investor’s income and taxed as per his/her income tax slab.Short-term capital gains (STCG) are added to an individual’s income and taxed as per the income tax slab. Long-term capital gains (LTCG) are taxed at 20% with indexation benefit.
SIP optionThere is no SIP option while making a fixed deposit. A depositor has to invest a lumpsum amount.An investor can make a lump sum deposit in a liquid mutual fund or avail of the SIP option. The SIP usually starts from Rs. 500 a month.
LiquidityA fixed deposit comes in with a fixed tenure. However, banks do allow pre-mature withdrawal (partial or full) with a penalty. However, pre-mature withdrawal cannot be made for a 5-year tax-saving FD.There may be a small exit load if the investor redeems within the first 6 days in liquid mutual funds.
Loan facilityA depositor can avail a loan against the fixed deposit from the same bank where he/she has made the FD. Usually, banks give loans up to 85-90% of the deposit amount. However, you cannot get a loan against a 5-year tax-saving FD.An investor cannot avail of a loan against liquid mutual fund units
Transparency of informationSmall investors have minimal idea of where the bank is lending their fixed deposit money. If there are colossal borrower defaults, resulting in huge NPAs, it can lead to a solvency problem for a bank. So, loan information transparency is not there in the case of banks.A debt mutual fund scheme is very transparent about where it is investing the money collected from investors. The AMC discloses the detailed portfolio for all schemes every month in the form of factsheets.
CostsBanks do not charge setup or maintenance costs for FDsA debt fund charges a nominal expense ratio. If you invest in a direct plan, your expense ratio will be lower.

Should you go for debt mutual funds or fixed deposits?

After going through the above comparison table, you must be wondering whether you should go for debt mutual funds or fixed deposits as an investor. To answer that question, consider the following points:

Taxation on maturity/redemption:

The interest on bank fixed deposits is added to an investor's income and taxed as per his/her income tax slab. Whereas, in the case of debt mutual funds, the LTCG is charged at a flat rate of 20% with indexation benefit. Suppose you are in the 30% tax bracket. Then, choose debt mutual funds over bank fixed deposits if your investment tenure is three years or more from a taxation perspective.

Liquidity and exit charges:

Some liquid mutual fund schemes provide the insta-redemption service. With this service, you can redeem your mutual fund units up to a specified amount, say Rs. 50,000 or 90% of your fund value, instantly in your bank account. In addition, most liquid mutual funds don't have an exit load beyond 6 days of investment. In the case of bank fixed deposits, you may have to visit the branch with the fixed deposit receipt (FDR) to make a partial/complete pre-mature withdrawal. Also, most banks will charge a pre-mature withdrawal fee. So, on the liquidity and exit charges front, liquid mutual funds fare better than fixed deposits.

Safety of capital:

In the case of fixed deposits, even if the borrower to whom the bank has lent your fixed deposit money defaults, the bank will still pay you on maturity. So fixed deposit investments are safe. Even if the bank goes bankrupt, up to Rs. 5,00,000 of your deposits is insured by the DICGC. For mutual funds, the risk of default by the borrower is borne by the investors of that scheme. Also, there is no insurance for your mutual fund investment. However, suppose you invest in liquid mutual funds that invest in securities with high credit ratings, such as Government securities and other money market securities with maturities of less than 91 days. In that case, the instances of default are rare.

Keeping in mind the taxation aspects, liquidity, and exit charges, liquid mutual funds have the edge over bank fixed deposits. 

However, everyone's requirements are different, and the same product may not suit everyone's requirements. Hence, consider your needs and circumstances and decide whether you should invest in liquid mutual funds or bank fixed deposits.

How do Debt Funds And Fixed Deposits Adapt to Inflation?

Inflation decreases savings by causing currency values to depreciate, as everyone knows. Debt mutual funds, despite the risk, have the ability to stay up with inflation. If you deposit money into a 6 per cent interest savings account and the inflation rate is 5%, your adjusted return will be only 1%. Debt funds may outperform equity funds in terms of returns.

ParticularsDebt FundsFixed Deposits
Invested sum (Year of purchase-2015)Rs 2,00,000Rs 2,00,000
Return rate7%7%
Holding period3 years3 years
Fund worth at the end of tenureRs 2,45,000Rs 2,45,000
InflationAdjustment availableAdjustment not available
Indexed Cost of Acquisition (Year of sale-2019)Rs 2,20,472
Taxed AmountRs 24,528Rs 45,000
Tax to be paid (assuming highest tax bracket of 30%)Rs 4,906 (Tax rate applicable is 20%)Rs 13,500
Returns after taxRs 40,094Rs 31,500

The Bottom Line

If capital security and guaranteed returns are your top priorities, a fixed-income investment is a way to go. When comparing Debt Fund vs FD, you can earn potentially greater risk-adjusted returns by investing a portion of your fixed-income assets in debt mutual funds. You can also enjoy tax benefits in debt mutual funds, which is the main advantage of debt mutual funds.

To know about the best debt mutual funds, you should consider and invest in them, download the Glide Invest App from Google Play Store or Apple App Store and get started.


Q1: How do you go about investing in debt funds?

A1: Through the asset management company, you can invest in direct debt fund schemes. You could invest in regular debt fund programmes with the help of a mutual fund distributor. 

Q2: Can debt mutual funds be considered a smart investment?

A2: Investors with a low risk tolerance should consider debt funds. To achieve consistent returns, debt funds typically diversify across various securities. While no assurances can be made, the returns are usually within a reasonable range. As a result, low-risk investors like them.

Q3: Is it possible to take money out of my FD before it matures?

A3: Banks make it simple to withdraw money from an FD early by charging a penalty.

Q4: What type of Investors should put their money into debt funds?

A4: Debt funds are a good option for investors who seek to attain short- or medium-term financial goals. Aside from that, debt funds are a good option for consumers who wish to diversify their portfolios or have extra cash.

Q5: Is there a time limit on debt mutual funds?

A5: No. Debt funds do not have a lock-in period. You are free to withdraw your funds at any moment.

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