Mutual Fund vs. Fixed Deposit – Key Differences, Benefits & Return Rates
Invest as per your risk profile
People have different kinds of risk profiles. They have either an aggressive, moderate, or conservative risk profile. For people with a conservative risk profile, bank fixed deposits are one of the investment options. Similarly, for people with an aggressive risk profile, equity mutual funds are one of the investment options. This article will focus on the features of these products and how an investor can choose between FD or mutual funds.
What are fixed deposits?
A fixed deposit is a financial product wherein an individual has to invest a fixed amount at a fixed interest rate for a fixed period. For example, Karan invests Rs. 1 lakh in a fixed deposit for one year at an interest rate of 6% p.a. In a fixed deposit, the three fixed components include:
- Fixed amount: Karan has invested a fixed amount of Rs. 1 lakh.
- Fixed period: Karan’s fixed deposit tenure is fixed at one year.
- Fixed interest: Karan will get a fixed return of 6% p.a.
What are mutual funds?
A mutual fund scheme is a collective investment scheme. The fund house collects money from all investors under the scheme. The fund manager invests the money as per the scheme's objectives. The investors are allotted the scheme units in proportion to their investment. The fund house declares the net asset value (NAV) of the scheme at the end of every business day. The NAV varies depending on the value of the underlying assets held by the scheme. The profit or loss of the investor will depend on the difference between the NAV at which they bought the scheme units and the current NAV.
Now that we understand the concept of FD and mutual funds, let us understand the difference between FD and mutual fund.
FD vs mutual fund
Let us look at some differences between a mutual fund vs fixed deposit.
|Feature||Fixed deposit||Mutual fund|
|Mode of investment||You have to invest a lumpsum amount in a fixed deposit.||You can invest either a lumpsum amount or start a systematic investment plan (SIP) in a mutual fund.|
|Risk||In an FD, the risk is borne by the bank and not the investor.||In a mutual fund, the risk is borne by the investor and not the AMC.|
|Returns||An investor gets a fixed return in a fixed deposit. The rate of return is specified at the time of making the FD.||There are no fixed returns in a mutual fund. The returns will depend on the performance of the underlying assets held by the scheme.|
|Types||FD is a debt instrument.||A mutual fund can be either an equity, debt, or hybrid scheme.|
|Insurance||In a bank FD, the DICGC provides insurance cover up to Rs. 5 lakhs subject to certain terms and conditions.||There is no insurance cover for the amount invested in a mutual fund.|
|Taxation||The interest earned on a fixed deposit is added to the investor’s overall income and taxed as per their income tax slab.||The capital gain earned on a mutual fund scheme is taxed depending on whether it is an equity scheme or some other scheme.|
The above differences will help you decide whether you should go for an FD or mutual fund.
Return on mutual funds
The return from a mutual fund scheme will depend on the type of the mutual fund scheme.
- Equity funds: They have the potential to give inflation-beating high returns. However, they carry high risk and are suitable for investors with an aggressive risk profile.
- Debt funds: They have the potential to give low or moderate returns. They carry low risk and are suitable for investors with a conservative risk profile.
- Hybrid funds: They have the potential to give moderate returns. They are suitable for investors with a moderate risk profile.
Return on fixed deposits
As discussed earlier, the return on fixed deposits is fixed. The rate of return is specified at the time of making the fixed deposit. The return remains fixed throughout the tenure of the fixed deposit. In the case of a cumulative fixed deposit, the interest is compounded quarterly, and on maturity, the investor gets the principal and interest.
Benefits of investing in mutual funds
Mutual funds are a very flexible product. An investor can choose to invest in equity, debt, or hybrid mutual fund schemes based on the risk profile. As per asset allocation, an investor can choose to invest a specified percentage of their portfolio in a combination of different types of mutual fund schemes. A qualified and experienced fund manager invests the money on behalf of investors. The fee (expense ratio) is low in mutual funds. The redemption process is easy and smooth. The investor gets the money in their bank account in two working days.
Mutual fund schemes are an excellent product to invest in for achieving various financial goals such as planning for a child’s higher education, own retirement, etc. An investor can start a systematic investment plan (SIP) with small monthly contributions.
Benefits of investing in fixed deposits
Bank fixed deposits are a good investment option for investors with a conservative risk profile. There is no upfront cost for investing in a fixed deposit. The bank bears the investment risk. The investor gets a fixed rate of return which is communicated at the time of making the fixed deposit. In case of a bank failure, the investor is protected by DICGC with an insurance cover of up to Rs. 5 lakhs subject to certain terms and conditions.
Choosing between a fixed deposit and a mutual fund
An investor can choose between a fixed deposit or a mutual fund depending on their risk profile. For short-term investments, you can go for fixed deposits. However, equity mutual funds are an appropriate investment product for long-term financial goals.