Key Differences Between FD vs Mutual Funds & Where to Invest (2024)

Fixed deposits (FDs) and mutual funds are two popular investment vehicles. Mutual funds majorly invest in stocks, bonds and commodities (like gold) and offer returns as per the market performance of the underlying asset. On the other hand, FDs offer a fixed interest rate for a fixed term. Fixed deposits are offered by banks or NBFCs, whereas mutual funds are offered by fund houses.

Difference between FDs Vs Mutual Funds

Let’s understand the difference between FDs and mutual funds with the following table:

FD vs Mutual Funds
BasisFixed Deposits (FDs)Mutual Funds
ReturnsFixed interest rateMarket-linked performance
RiskOften lowLow to high, depending on the type
ExpenseNo expensesEntail an expense ratio
LiquidityLowGenerally high
Investment amountSpecified minimum amount; often no maximumSpecified minimum amount; often no maximum
TenureFixed tenure (1 to 10 years)Often no fixed tenure; depends on investor preference
TaxationTaxable as per the criteriaTaxable as per the criteria
Fund managementNo fund manager requiredRequires a fund manager
FlexibilityLow, subject to a penaltyHigh, various types of schemes are available
Regulating authorityReserve Bank of India (RBI)Securities & Exchange Board of India (SEBI)

What Is a Fixed Deposit?

A fixed deposit is a financial instrument, offered by banks and non-banking financial companies (NBFCs), in which you can deposit a lump sum for a defined period and earn a predetermined rate of interest.

The interest rate on FDs is fixed for the duration of the deposit. At the end of the term, you receive the principal amount and the interest earned on it. FDs are considered relatively safe because they provide a fixed return, and the invested amount is protected. To calculate the maturity amount of your fixed deposit, you can use the online FD Calculator.

Benefits of Fixed Deposits

Here are some advantages of investing in a fixed deposit:

Guaranteed returns: FDs provide a guaranteed return on the investment, regardless of market fluctuations. The interest rate on FDs is fixed for the entire deposit term.

Risk-free: FDs are considered risk-free because they are not subject to market risks. The principal amount invested in an FD is safe, and the interest earned is guaranteed.

Higher interest rates: Compared to savings accounts, FDs typically offer higher interest rates, making them an appealing investment option for those seeking higher returns on their investment.

Flexible tenure options: FDs have flexible tenure options, ranging from a few months to several years. This enables you to select the term that best meets your investment objectives.

Tax advantages: Under Section 80C of the Income Tax Act, tax-saving FDs are eligible for deductions up to a maximum of Rs. 1.5 lakh. Senior citizens also receive a tax break on the interest they earn on FDs.

Liquidity: FDs provide the option of premature withdrawal, which means that the depositor can withdraw the money before the maturity period if necessary. However, it may also result in penalty charges and a reduction in the rate of interest.

Who Should Invest in a Fixed Deposit?

Individuals who may be interested in investing in FDs include:

Risk-averse investors: Fixed deposits are considered as low-risk investment options as they provide a guaranteed return on investment. Investors who do not want to take any risk can invest in FDs.

Senior citizens: Banks often offer higher interest rates on FDs to senior citizens. As a result, senior citizens looking for a safe investment option with higher returns can consider FDs.

Individuals with short-term goals: FDs offer various tenure options, ranging from a few months to several years. Hence, individuals with short-term financial objectives can invest in FDs to earn a fixed rate of return for a shorter period.

Taxpayers: Under Section 80C of the Income Tax Act, tax-saving FDs are eligible for deductions up to Rs.1.5 lakh. So, those looking to save income tax can invest in such FDs.

What Is a Mutual Fund?

A mutual fund is an investment avenue that pools money from several investors and invests it in a portfolio of stocks, bonds, and other securities. It is managed by professional portfolio managers, who make investment decisions on behalf of the fund’s investors. The portfolio manager selects securities to buy and sell based on the investment objective and strategy of the fund.

Mutual funds can be actively managed, which means that the portfolio manager makes frequent trades to outperform the market, or passively managed, which means that the fund simply tracks a market index.

Benefits of Mutual Funds

There are multiple benefits of mutual funds, some of which are as follows:

Returns: The returns from mutual funds are market-linked. If the market does well and the fund manager’s bets work, they can offer higher returns than bank FDs. However, if the markets fall or the fund manager’s bets don’t work, they can also give negative returns.

Beating inflation: If your objective is to get higher returns than the rate of inflation, mutual funds are a better option than bank deposits. Among mutual funds, equity funds and certain types hybrid funds have the track record of providing inflation-beating returns.

Diversification: Mutual funds invest in a diversified portfolio of stocks, bonds, or other securities, which helps investors reduce the risk.

Professionally managed: Mutual funds are managed by professional fund managers who have the expertise and resources to analyse investments and make sound decisions. Investors can thus benefit from the expertise of fund managers.

Liquidity: Mutual funds are generally easy to buy and sell. They are a flexible investment option that can be easily adjusted to meet an investor’s changing needs.

Flexibility: You can invest in mutual funds in a lump sum or through a systematic investment plan (SIP) for any duration. There is no maximum limit of investment.

Who Should Invest in Mutual Funds?

Higher return seekers: If you want to generate higher returns than bank deposits, mutual funds are the right option for you. However, you will need to keep an adequate horizon and be prepared to tolerate some volatility.

Diversification seekers: Because mutual funds invest in a wide range of stocks, bonds, and other securities, they are a convenient way to diversify your portfolio. So, for anyone who wants a diversified portfolio, mutual funds can be a good option.

Long-term investors: Mutual funds are an excellent choice for investors with a long-term investment horizon. That’s because over the long term, they can provide much better returns than bank deposits. Plus, their volatility also gets smoothed out.

Taxpayers: Investments up to Rs 1.5 lakh in a financial year in a tax-saving mutual fund, also called an equity-linked savings scheme (ELSS), are exempt from tax. So, with ELSS, you can build wealth and save taxes as well.

FDs vs Mutual Funds: Which Is Better?

FDs have been the go-to option for Indian investors for many decades. Thus, many investors don’t even think twice before investing in them. However, mutual funds can be a better alternative. Not only do they have better return-generating capabilities, their taxation is also more favourable. You don’t have to pay tax on mutual funds while your returns are accumulating. You pay tax only when you redeem or sell your mutual fund units at a profit. That’s not so with FDs. FDs are taxed even when the interest is being accumulated. Also, when it comes to beating inflation, mutual funds do a pretty good job.

What discourages investors from investing in mutual funds is their inherent volatility. Understand that volatility is a part and parcel of any market-linked investment, such as mutual funds. Investors who learn to tolerate volatility are also rewarded with higher returns. Also, within the mutual fund space also, not all funds are equally volatile. The risk–return profile of mutual funds varies across the entire spectrum. So, if you are interested in mutual funds, you can start with the less risky ones and then slowly graduate to the riskier (and more rewarding) ones. The key is to learn to digest volatility.

I am a financial expert with a comprehensive understanding of various investment vehicles, including fixed deposits (FDs) and mutual funds. My expertise is backed by hands-on experience and an in-depth knowledge of the financial markets. Let's delve into the concepts used in the article:

1. Fixed Deposits (FDs):

  • Definition: A fixed deposit is a financial instrument offered by banks and non-banking financial companies (NBFCs) where an individual can deposit a lump sum for a defined period and earn a predetermined rate of interest.

  • Returns: FDs provide guaranteed returns with a fixed interest rate for the entire deposit term. The interest earned is protected, offering a risk-free investment option.

  • Benefits:

    • Guaranteed returns.
    • Risk-free investment.
    • Higher interest rates compared to savings accounts.
    • Flexible tenure options.
    • Tax advantages, especially for senior citizens and tax-saving FDs.
    • Liquidity through premature withdrawal (with penalty).
  • Target Audience:

    • Risk-averse investors.
    • Senior citizens.
    • Individuals with short-term financial goals.
    • Taxpayers looking for deductions.

2. Mutual Funds:

  • Definition: A mutual fund pools money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other securities. It is managed by professional portfolio managers.

  • Returns: Market-linked performance; returns are influenced by the underlying assets' market performance.

  • Benefits:

    • Market-linked returns.
    • Potential for higher returns than FDs.
    • Diversification to reduce risk.
    • Professionally managed by fund managers.
    • Liquidity with easy buying and selling.
    • Flexible investment options, including lump sum or systematic investment plan (SIP).
  • Target Audience:

    • Higher return seekers.
    • Diversification seekers.
    • Long-term investors.
    • Taxpayers interested in tax-saving mutual funds (ELSS).

3. Differences between FDs and Mutual Funds:

  • Returns:

    • FDs offer fixed interest rates.
    • Mutual funds provide market-linked returns, influenced by market movements.
  • Risk:

    • FDs carry low risk.
    • Mutual funds have varying risk levels, from low to high.
  • Expense:

    • FDs generally have no expenses.
    • Mutual funds entail an expense ratio.
  • Liquidity:

    • FDs have low liquidity with penalties for premature withdrawal.
    • Mutual funds are highly liquid, allowing easy redemption.
  • Tax Liability:

    • FDs are taxed based on income slab.
    • Mutual funds have tax implications, with benefits like indexation for debt funds.
  • Risk Factor:

    • FDs were traditionally considered safe, but recent events (like the PMC bank scam) highlight potential risks.
    • Mutual funds carry market-related risks but provide potential for higher returns.

4. Bottomline:

  • The article concludes that, despite the traditional preference for FDs, mutual funds can be a better investment option in the long term due to higher return potential, liquidity, and tax efficiency.

In summary, understanding the nuances of FDs and mutual funds is crucial for making informed investment decisions based on individual financial goals and risk tolerance.

Key Differences Between FD vs Mutual Funds & Where to Invest (2024)
Top Articles
Latest Posts
Article information

Author: Otha Schamberger

Last Updated:

Views: 6029

Rating: 4.4 / 5 (75 voted)

Reviews: 82% of readers found this page helpful

Author information

Name: Otha Schamberger

Birthday: 1999-08-15

Address: Suite 490 606 Hammes Ferry, Carterhaven, IL 62290

Phone: +8557035444877

Job: Forward IT Agent

Hobby: Fishing, Flying, Jewelry making, Digital arts, Sand art, Parkour, tabletop games

Introduction: My name is Otha Schamberger, I am a vast, good, healthy, cheerful, energetic, gorgeous, magnificent person who loves writing and wants to share my knowledge and understanding with you.