Understand the difference between fixed deposits and debt mutual fund and which one to choose debt funds or FD (Fixed Deposit) and when
Common Indian investors, when considering debt mutual funds, assume they are the same as Fixed Deposit. However, they are a lot of differences. So, knowing can help understand which one to choose when?
As an investor, if you prefer investing in debt but struggling to decide which is a better choice of investment – fixed deposits or debt funds, let me share the pros of each to help you choose accordingly.
But, first, let’s understand what each of them is:
What is a Debt Mutual Fund?
The debt funds are those mutual funds scheme that invests in the money market products such as government bonds, corporate bonds, etc.
There are many categories of debt mutual funds, aka Liquid Funds, Credit Risk Funds, Ultra Short term funds, etc.
The debt mutual funds are also referred to as fixed-income funds and are commonly known as debt funds.
What is a Fixed Deposit or FD?
A fixed deposit (FD) is a financial instrument provided by banks or NBFCs, which offers investors a rate of interest as per the term of the deposit.
Ideally, one can’t withdraw the money before maturity in a Fixed Deposit.
However, we have an option to break the FDs as and when one wants to. The only caveat will be one may lose the returns for the last period. It means if your interest is credited quarterly, you may lose the interest for the past quarter.
Breaking of FDs generally doesn’t lead to loss of capital. However, it is better to read the terms of the FDs if you have plans to withdraw the FD prematurely.
The tenure of an FD can vary from a week to as long as a decade.
The vital aspect of Fixed Deposit is – they are covered by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which is a subsidiary of Reserve Bank of India.
However, DICGC guarantees only ₹ 1Lakh per depositor per bank.
How Fixed Deposits Differs from Debt Mutual Funds?
I am damn sure looking at the definition itself, you have started to realize how debt mutual funds and FDs aren’t the same.
One invests in the money market, and other helps bank and NBFCs provide cash for its business.
So debt funds come with the risks of the money market. Moreover, returns from FDs are insured by RBI.
So now, let’s look at other significant differences between FDs and debt funds.
| Debt Fund | Fixed Deposit | |
|---|---|---|
| Risk | Higher | No-Risk |
| Returns | High (Depends on Debt Fund) | Lower as compared to debt funds |
| Expense Ratio | Managing the fund has an expense which is deducted from the investment as the expense ratio | No expense |
| Liquid | One can withdraw at any point without too much impact on returns. | Ideally, one can withdraw only at maturity. However, one has an option to break the FDs. |
| Taxation | Depending on the type of fund, it may be subject to short term and long term capital gains tax. | FDs are subject to tax as per individual’s tax slab if the amount earned is over ₹10,000 in a financial year. |
Benefits of Investing in Debt Funds
Some of the common benefits of investing in debt funds are:
- Higher returns with minimal risk.
- One can start investing for as low as ₹500 per month.
- Funds reduce risk through diversification of investment in various instruments, including government bonds.
- Many options to invest – Systematic Transfer Plan, Systematic Investment Plan, Lump sum.
Benefits of Investing in Fixed Deposits
Some of the common benefits of investing in FDs are:
- No risk (RBI Backed).
- The guaranteed rate of returns.
Why do Investors consider Both as Same?
They assume the assured return is the same as guaranteed returns.
There is a wordplay here.
Debt funds when they invest in corporate bonds, the risk is higher. Moreover, there is no guarantee of returns. However, in FD, as we have seen, the returns are guaranteed.
In an FD certificate, you will get the calculated final amount as receivable after the maturity period. In debt mutual funds, there is no final amount. As the money market investments perform, the NAV changes.
Which One to Choose When – Fixed deposit or Debt Funds?
In terms of risk, FD is a better choice as it has no risk.
In terms of returns, a debt fund is a better choice with a slight bit of risk.
The choice is yours.
Final Thoughts
As an equity investor, I avoid both. I have no investment in debt schemes because I like to keep my cash in my bank account so as and when the equity market provides me with opportunity, I want to grab it with both hands.
However, for those who want to diversify into various asset classes, one can consider it. I am more inclined as a focus investor with a riskier choice for better returns.
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