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Most of the investors in India are risk-averse and prefer choosing safe investment avenues. Even with a large number of structured products being offered to Indian investors, the popularity of fixed deposits (FDs) is high. FDs are offered by the banks and provide slightly better returns than the saving bank account. One reason for their continued popularity is the guaranteed return on investment at the time of maturity.

Most investors fail to overlook the inflationary increases and tax liabilities while calculating the return on FDs. It is, therefore; not surprising that on a closer evaluation, investing in FD may actually result in a loss for the investors.

A better albeit riskier option is investing in mutual funds (MFs); which are professionally managed by experienced fund managers. Various fund houses offer different options, which makes it easier to find one that most appropriately suits an individual investor’s needs.

Differences between FD and MF

Returns

FDs guarantee the returns on the initial investment at the time of maturity. These are based on the investment amount, tenure, and the age of the investors. In comparison, returns on mutual funds are based on the market performance of the asset class and are not guaranteed.

While investing, considering the effects of inflation on the overall returns is important. Opting for financial products that provide profits exceeding the inflation rate is prudent. Adjusting the guaranteed fixed deposit rates for the inflationary increase will give investors the exact profits they will make on their invested capital.

Risks

Banks offer guaranteed returns on the FD at the time of investing. Any fluctuations in the market conditions and interest rates do not affect this return. On the other hand, MF returns are directly related to the performance of the asset class in which the capital is invested. Therefore, investing in MF is riskier than FD but offers a better opportunity for investors to earn higher returns.

Liquidity and premature withdrawal

MFs are more liquid than FDs because the latter cannot be withdrawn before the maturity date. If an investor needs to prematurely withdraw the FD investment, he or she will need to pay high penalties. Most MFs do not have a specific lock-in period unless equity linked funds, which provide tax benefits. However, an investor may have to pay an exit load (fee) if he or she liquidates the investment before one year from the date of purchase. Checking the exit load before making the investment is advisable.

Investment costs and expenses

Investing in MFs has certain costs and associated expenses, which vary based on the type of fund chosen. The returns on the investments are adjusted for these expenses. FDs, on the other hand, have no initial investment expenses and the entire returns are available at the time of maturity.

Tax implications

Understanding the tax implications of any investment before making the decision is vital. Returns on MFs are classified as capital gains while the fixed deposit interest earnings are classified as income. This means the entire interest earned on the FDs is taxable. Investors must pay the tax as per their income tax slab rate. In comparison, long-term capital gains (investments redeemed after one year) made on equity MFs are tax-free and short-term capital gains are taxed at 15%. Long-term returns on debt MFs are taxable at 20% (with indexation) and 10% (without indexation). Investors must pay short-term capital gains tax as per their tax slab rates for debt MFs.

Each of these two financial products has specific pros and cons. In addition, to understand these, an investor must consider his or her risk profile and investment period before making the choice.

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