Mutual Funds vs Fixed Deposits – Know Which is Better Investment Option

In this SAMCO Investor Education Series, we will cover a topic of Mutual funds Vs Fixed deposits. In this article we will cover in-depth comparison between two of the most popular investment options, their characteristics, advantages & limitations of investing in each instrument, risk vs. return and lot more which will be helpful for the investors to take informed investment decisions.

Both mutual funds, as well as fixed deposits, are very popular investment options in India in recent times. Though Indian investors always considered traditional fixed deposits as the most preferred and risk-free investment option, with changes in global trend and availability of more information in hands, investors are considering shifting their wealth slowly and gradually towards the mutual funds which can create real inflation beating wealth for the investors in long term. Mutual funds come in various categories as per the requirement of the investors.

FIXED DEPOSITS – Is It Really A Good Choice To Invest?

When it comes to saving money, people often opt for fixed deposits, considering them to be relatively risk-free instrument giving guaranteed returns. Though security of having money in the bank is considered a great factor, but with changing macro factors and inflation, improvement in lifestyle, nuclear family concept and increased expenditures, investors need to introspect that investing in FD is actually saving of money or rather losing of it?

Fixed deposits may give attractive returns on paper, but with the tax payable at the current tax slab, the more one invests in FDs, the more tax one has to pay. In today’s environment where FD returns are not more than 6-6.5% annually when we consider the rate of inflation over the recent years, its almost same as returns from FD. So in simple words, if an investor is earning 6% return on his FDs, his expenses are also increasing by about 6% because of the inflation. Therefore it is possible that one might not be making any inflation-beating returns but actually, be facing a loss by investing in FDs.

MUTUAL FUNDS – The Next BIG Thing!!

In the case of Mutual funds, the scenario is completely different. Although Mutual Funds are affected by market fluctuations and do have a level of risk as per their categories, they are managed by professional fund managers assisted by an expert team of analysts by monitoring investment opportunities in different sectors, who do their best not only to protect investments of the investors but also to grow it over a period of time.

Mutual funds are generally low-risk forms of investment as compared to direct investment in the stock market, and provide investors with good returns over a substantial period of time. However, there are certain differences between mutual funds and fixed deposits that makes one form of investment more attractive than the other and vice versa which we will discuss further in detail in this article.

Watch this video to understand the basics of mutual funds:

When it comes to the rate of returns, FD rates are pre-specified and do not change for the entire tenure irrespective of market movements. On the other hand, MF rates are affected by market conditions, hence during positive market conditions, Mutual funds have the potential to earn high returns whereas FD rates are unaffected. But as seen from the recent past data, over a long period of time such as 5 years or above, mutual funds has always given better risk-adjusted returns as compared to FD and grown investor’s wealth irrespective of market volatility in between the time.

In terms of risk, FDs are generally known for minimal risk, whereas equity mutual funds carry high market risk, and debt mutual funds carry lower market risk than equity. But risks can be mitigated to a certain extent as mutual funds have expert management team who does the work on the behalf of the investors. Yet, Mutual funds are prone to market risk. But as it is said, big risks give big returns.

Below we have compared both of the instruments on the basis of various parameters which an investor shall consider before investing his hard earned money to fulfill his responsibilities and life goals.

Key Pointers Mutual Funds Fixed Deposits
What is the Fundamental Difference? A mutual fund is an investment fund that pools money from many investors and managed by professional fund managers to purchase securities such as equity shares of various companies from different sectors, treasury bills, certificate of deposits, commercial papers of various companies and other similar securities on behalf of the investors. Fixed deposit, as the name suggests is an investment option which locks in the investor’s investment for specific period of time.
Brief explanation of investing in mutual funds vs fixed deposits. Mutual funds are a portfolio of stocks of companies from diverse range of sectors such as Infrastructure, Pharma, Banking, Oil & Gas etc. which include equity shares, corporate bonds and debentures of such companies. All this investments are done by expert fund manager who takes care of the selection as well as the trade of stocks for investment as per the scheme’s investment objective, which saves a lot of time and money for the investors. When an investor invests in a fixed deposit with a bank or corporate, it comprises entirely of fixed income instrument which will give guaranteed regular interest income and return of principal at the end of the investment tenure.
Example of Mutual Funds Vs Fixed Deposit Mutual funds are a collection of stocks and bonds which are managed by professional fund managers in an Asset Management Company (AMC). If it is an equity mutual fund, it will contain equity stocks, while debt mutual funds will contain corporate bonds, government securities, treasury bills and bonds. A mutual fund is like a huge bucket of shares from various companies from diverse range of sectors. For example, L&T Emerging Businesses Fund in a Small Cap sector consists of stocks of approx 85 companies from different sectors such as Engineering, Chemicals, Manufacturing, Banking/Finance, Retail & Real Estate and Automotive etc. An investor invests Rs. 1,00,000/- in a 5 year fixed deposit with XYZ bank @8% interest annually. He will earn a taxable interest of Rs. 8000/- per annum fixed irrespective of market movement. At the end of 5 years tenure, bank will give his principal of 1,00,000/- back along with 5th year’s interest. So investor has earned a return of 8% which will get include in his total income for that year and taxed according to his tax slab.
Note – If the FD interest amount exceeds Rs. 10,000/- in any year, then bank will deduct the tax at source (TDS) and the interest amount net of tax will be paid to the investor.
Need of a demat account Mutual funds do not need a demat account but if investor have a demat account then he can link his mutual funds portfolio to get access to all his Stocks & Mutual fund’s holding under a single demat account. Investment in fixed deposits does not need a demat account either. An investor just needs to have a bank account with a bank he wants to make his FD and submit required documents for KYC purpose. After that he can initiate to invest in FD.
Form of Investing Mutual fund investments are a passive or indirect form of investment in stocks, securities & bonds that is managed by an asset management company or investment house which has a dedicated fund manager for each scheme. In case of fixed deposits, investor does not need to do anything. He will get guaranteed interest for the term of FD and his principal back at the end. However this return from FD is very less or negligible when we consider the after tax returns and inflation factor. It barely makes any inflation adjusted returns which the investor can really enjoy.
Efforts vs. Reward Mutual fund returns can range from 6% to 15% per annum or more, depending on the type of scheme one has invested in. The safest category is a liquid fund which can fetch about 6%, which is an extra 1% compared to a savings account without any risk. There are also mid cap & small cap mutual fund schemes which have historically delivered returns of 15% or more in the past few years. As all investment decisions are taken by a fund manager, investor doesn’t need to continuously track the market.

If an Investor makes an investment in a moderately risky mutual fund then he can easily expect a return of around 12% per annum which doubles the initial corpus invested every 7 years without bothering to track markets on a daily basis. So efforts-to-reward ratio is very good in mutual fund investments.

In case of fixed deposits too, an investor does not have to play any active role for fetching returns. He does not have to bother about market fluctuation or economic conditions of the country. He will get his guaranteed returns which was agreed at the time of investment. However in case of FDs, if the economy and market performs well investor will only get his fixed amount of returns and he won’t be able to participate and gain from good times in the markets.
Therefore despite of having no direct involvement of the investor after the investment in both Mutual funds as well as FDs, in mutual funds, he will be able to take benefit of good markets by fetching higher returns which is not the case if he would have invested in FDs. Hence efforts-to-reward ratio is very less in FD as compared to Mutual funds.
Risks involved in investment of mutual funds vs fixed deposits Mutual funds are managed by professional fund managers with their dedicated research team in the AMC who have sufficient knowledge of the markets along with resources & capital to track the complicated financial markets. For this reason, this expert management of investor’s portfolio makes mutual funds ideal for investors who want to invest in financial markets as per their risk taking ability and financial goals. In case of fixed deposits the interest amount is fixed along with the guaranteed payback of the principal at the time of maturity. So there is virtually no risk in case of FDs as investor will get his returns irrespective of behavior of markets and state of the economy.
Expenses and liquidity to the investor in the mutual funds vs fixed deposit In mutual funds, investors need to pay fund management charges which automatically gets adjusted in the Net Asset Value (NAV) of the scheme and exit load upon sale of units only if the investor redeems his investments before 1 year of investment in case of equity oriented mutual funds which is usually 1% of the market value. For debt oriented mutual funds it is,

> 3% of market value if redeemed before 1 year

> 2% of market value if redeemed before 2 years

> 1% of market value if redeemed before 3 years of investment.

Mutual funds only charge an exit load if investments are withdrawn, in a very short period. Hence, we can say that mutual fund investor with a tenure of 5 years enjoys more liquidity as compared to 5 year FD investor.

In case of Fixed deposits, if an investor invests on 1 September 2017 for 3 years at 8%. After one year, because of some financial urgency, he wants to withdraw his FD and take his money back on 1st September 2018. The applicable interest rate for one year fixed deposit in the bank at the time of opening of his FD was 6.5%. So he will earn 6.5% per annum for his deposits and not the original rate of 8%. It is called premature withdrawal penalty.

Thus, investment in FD has a low liquidity till the period of deposit ends, which is not the case with mutual funds as they provide high liquidity to the investors as compared to FDs.

Time horizon  In Mutual fund various options are available an investor can select any as per his requirements. If investor invests in

-Debt oriented accrual funds which invest in high rated papers of the corporate and government, it can earn returns up to 8% per annum with negligible risk as compared to 6.5% in FD.

-Equity oriented large cap, mid cap or small cap funds which have moderate risk to high factor, which can fetch returns in the range of 12 to 20% or more compounded annual returns to the investor in long term.

Investors usually invest in a FD for the time period of 1 year up to 5 years. This usually yields them a return of approx 6 to 6.5% net of tax. After adjusting for inflation of approx 6% in India, we can say that the real return of the investor after adjusting inflation is negligible. In a way FD merely maintains the value of money, rather than growing it.
Investment styles available An investor can invest in mutual funds through a fixed monthly Systematic Investment Plan (SIP), withdraw fix amounts monthly as per his requirements through Systematic Withdrawal Plan (SWP) or Transfer money from one scheme to another scheme through Systematic Transfer Plan (STP) to hedge against market volatility and liquidity needs. The passive nature of mutual funds makes it easier for anyone and everyone with money to invest even if the amount is extremely small such as Rs.500/- monthly. In case of FDs, investor cannot invest a very small amount such as Rs. 500 which is allowed in case of mutual funds. He have to invest a lump sum amount such as Rs 25,000 or so. At times if the investor have a small amount to invest (like from his monthly savings) then he has to wait to accumulate a lump sum amount to make an FD and this may cause him to lose the returns for that period of time which he could have made by investing in mutual fund. This loss of return is known as opportunity cost.
Tax benefits Tax benefits on mutual funds can be claimed under Section 80C if it is an Equity-Linked Savings Scheme (ELSS) which is one type with the lowest lock-in period of 3 years across all the investment options available under section 80C such as PPF (12 years), National Savings Certificate (7 to 8 years), Term deposit (5 years). The interest income from bank fixed deposit is fully taxable as per the income tax slab of the investor.In case of FDs, banks deduct tax at source (TDS) at the rate of 10 per cent if the interest income for the year is more than Rs 10,000.

In the end, the decision to invest between Mutual funds and Fixed deposits is based on the time horizon and risk taking capacity of the individual. But when the things are hopeful, and there are good prospects for growth of the economy, it makes greater sense to invest in mutual funds, because of the possibility of good returns.

This covers the vast topic of investing in Mutual Funds vs Fixed Deposits which is dilemma for many investors nowadays. We have covered in depth information about both of these instruments, their comparison, risk to return factor and advantages. For more details about mutual funds, investment and market trading go to our investor education section or visit

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(Note: This content is for information purpose only. Avoid trading and investing based on the information given above. Before investing in stocks or mutual funds, please conduct proper due diligence).

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