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.

In this blog, we will understand the difference between FDs and <a href=”https://www.etmoney.com/mutual-funds/invest-with-us”>mutual funds</a> in detail to find out which is the better avenue for our money. <h2>Difference between FDs and Mutual Funds</h2> Let’s understand the difference between FDs and mutual funds with the following table: The first thing that works in favor of Bank FDs is the assurance of guaranteed returns. Plus, you come to know how much you will get as the return amount at the time you invest the money. Different banks offer different returns on the money invested for different time-frames. That means, if a certain amount of money is invested in a Bank FD for three months, then its interest rate would be less than the interest rate of a 12-month FD. But, the bank guarantees to pay at the interest rate (at maturity) that it had promised to pay during the time the money was invested. Meanwhile, in case of mutual funds, there is no assurance of guaranteed returns and the return amount may move up and then down as per the market movements. But that does not mean that the returns will always run in the negative. In fact, in the long term, chances of getting higher returns from Mutual Funds are much more, compared to FD returns. Now if you want to make a short term investment,i.e. for one-three years,<a href=”https://www.etmoney.com/blog/what-are-debt-funds-how-do-they-work-and-how-are-they-different-from-equity-funds/”>Debt Mutual Funds</a>are the best option. The return for Debt Mutual Fund for such a duration would be 6-9 percent, and the Bank FD interest rate for the same period would be 6-8 percent. But if we compare one-year returns from Liquid Mutual Fund with FD returns of the same duration, we will see why the former can be called a better investment option. Looking at the past returns, the one-year return for both the products are more or less the same. However, in the case of Liquid Mutual Funds, there is no lock-in period. Moreover, even if you want to redeem the money on the seventh day itself, you do not have to pay a penalty for that. <h2>Liquidity</h2> Mutual funds are highly liquid. Its units can be redeemed at any time on a click of a few buttons and the money will be deposited to the designated bank account within two-three business days. In fact, in the case of several Debt Funds, no exit load is charged at the time of its encashment. On the other hand, if you want to redeem a Bank FD before its maturity period, you will have to pay a penalty on that. For example, as per the SBI rule, if you redeem an FD before its maturity period, you have to pay a penalty between .5-1 percent on the total amount. For example, if you encash a five-year Bank FD in the third year, then the return amount that you will get will be as per the interest rate of a three-year FD. Moreover, the penalty will be deducted from the return amount. <h2>Tax Liability</h2> The strength of a financial product depends on its rate of return; but, the real return of an investment is the post-tax returns – i.e. the money that you receive in hand after the tax amount is deducted from the total amount return. In the case of Bank FD, the percentage of this tax is as per your income slab. That means, if you fall under the 20 percent income tax slab, then you will have to pay a 20 percent tax on FD returns. Similarly, 30 percent, if you fall under the 30 percent tax bracket. On the other hand, long-term capital gains are levied on<a href=”https://www.etmoney.com/mutual-funds/debt”>debt-fund investments</a>, after the investment crosses three years. Accordingly, you will have to pay 20 percent tax, but then again, you get indexation benefits for Debt Funds investments.Indexation is a kind of tax relief provided by the government to the mutual fund investors. The short-term gain from the Mutual Fund returns, i.e. returns from investments lesser than three years, is added to the investor’s annual income; and taxed <h2>The Risk Factor</h2> One of the first criteria for any financial investment is how safe the money is. That way, a guaranteed safety factor is one of the biggest benefits of FDs, but that was before the PMC bank scam came into the light. So, in case of a bank default, you will only get the amount that has been insured, which is up to Rs 5 lakh. That is, even if you have invested Rs 10 lakh (in case the bank defaults) you will get Rs 5 lakh, which is the insured amount. Nowadays, all the banks stamp the necessary information about the Rs 5 lakh sum insured on the depositor’s passbook, as per the RBI rule of 2017. Meanwhile, even though there is no guarantee on the minimum Debt Mutual Fund return amount, a loss is possible only when one investor decides to redeem the money looking at the market movements. Bottomline: We refrain from investing in Mutual Funds, and instead put our money in Bank FDs, thinking the latter to be a much safer option of investment. But, in the long-term, Mutual Funds have the capacity to provide FD beating returns. Further, Mutual Funds are highly liquid and more tax efficient as compared to the benefits of FD. So, as per all the criteria discussed earlier, Mutual Funds makes a better investment option than FD.

Difference between FDs Vs Mutual Funds

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

FD vs Mutual Funds
Basis	Fixed Deposits (FDs)	Mutual Funds
Returns	Fixed interest rate	Market-linked performance
Risk	Often low	Low to high, depending on the type
Expense	No expenses	Entail an expense ratio
Liquidity	Low	Generally high
Investment amount	Specified minimum amount; often no maximum	Specified minimum amount; often no maximum
Tenure	Fixed tenure (1 to 10 years)	Often no fixed tenure; depends on investor preference
Taxation	Taxable as per the criteria	Taxable as per the criteria
Fund management	No fund manager required	Requires a fund manager
Flexibility	Low, subject to a penalty	High, various types of schemes are available
Regulating authority	Reserve 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.

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.

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.