Are mutual funds better than termed deposits to invest in?
Upstox
4 min read • Updated: February 22, 2024, 3:24 PM
Summary
When considering investment options, new investors often find themselves in a state of confusion. While FDs (fixed deposit) and Mutual Funds are two of the most popular investment alternatives, choosing between them can put one in a dilemma. As it goes with investments, carefully considering the pros and cons of each option will help budding investors make an informed choice.
Fixed Deposit
Term deposits, also known as fixed deposits, are an investment option provided by NBFCs (non-banking financial companies) and banks that allow investors to make lump sum deposits for a fixed tenure and earn interest.
FDs are considered one of the safest investments to make as they provide guaranteed returns, irrespective of fluctuations in the market. Furthermore, term deposits qualify for tax exemptions under section 80C. However, the cap for exemptions is set at ₹ 1.5 lakhs.
If you are a risk-averse investor with a low risk-taking appetite, FDs are the way to go. As of 2023, the State Bank of India held nearly 32% of the market share in term deposits across public sector banks. Term deposit interest rates can vary between 3% to 7.5% depending on the provider you choose to invest with.
However, new investors must learn how inflation rates impact their investments. An increase in the inflation rate can effectively reduce the real value of any interest earned. Equally concerning is the fact that the very value of money is stirred when inflation rises.
Consider the following to understand the matter further - Amar invests ₹ 100000 in a term deposit at 5% p.a interest, for a period of 3 years. Considering an inflation rate of 4%, the true value of interest earned would be 5% - 4%, which is 1%. In this scenario, Amar earned a paltry 1% on his investment. Not surprisingly, Amar would be upset.
Mutual funds
Simply put, mutual funds are investment instruments in which institutional and individual investors make combined contributions towards portfolios of bonds, stock, and various securities. Managed by asset management professionals, MFs offers a variety of investment options depending on the financial needs of the investor.
Mutual funds are subject to higher risk exposure as compared to term deposits. However, they can offer considerably higher returns as well. Moreover, unlike FDs, this option can help you beat inflation rates.
Buying and selling mutual funds is relatively uncomplicated and can provide much-needed flexibility, especially when the investor's needs change. Additionally, MFs can reduce investment risk on account of the diversified options available to invest in.
Suppose you are a risk-aware investor with a moderate to high-risk appetite. In that case, mutual funds are the way to generate higher returns than term deposits. ELSS (equity-linked saving scheme) is a mutual fund investment that helps investors generate wealth while saving on taxes.
Mutual funds are a great option for individuals who want to make long-term investments. This is because, in the long run, they have the potential to yield far higher returns than bank savings. Moreover, their volatility also becomes less pronounced.
| Criteria | Fixed Deposits | Mutual Funds |
|---|---|---|
| Risk | Low | Low to high, subject to market conditions |
| Returns | Fixed rate of interest | Linked to market performance |
| Expenses | No expenses | Subject expenses |
| Tenure | Fixed | Flexible |
| Regulated by | RBI | SEBI |
| Investor profile | Low risk appetite, Retirees, Individuals with taxable income, Guaranteed return requirements | Mid-high-risk appetite, seeking portfolio diversification or high returns |
Conclusion
Deciding between fixed deposits and mutual funds also requires a great deal of personal consideration to be made - What are your financial goals? How actively do you want to invest? What is the purpose of investing?
For a long time, FDs have been the preferred choice for Indian investors. As a result, many investors buy them without even giving them a second thought. On the other hand, mutual funds are not only more capable of producing returns, but they also offer tax benefits.