Fixed Deposits vs. Mutual Funds: Unravelling the conundrum
Most of us care little for the money lying idle in our savings bank account. While we are comforted by the idea that it will continue to accumulate interest, we rarely pause to think about the meagre rate of interest that banks pay.
Since the Reserve Bank of India (RBI) deregulated the interest on savings accounts over two years ago, the rate of interest offered on such accounts is limited to 4 per cent. Yes, some banks do offer the higher interest rate of 6 per cent, but you need to maintain a minimum deposit to get the benefits. Wouldn’t it be nice if there existed an alternative? What if you could park the idle cash and earn almost 8 per cent interest?
Read about liquid mutual funds. Acting as a viable alternative in the short-term, these mutual funds allow you the option to pull out your investments whenever the need arises.
Why choose liquid mutual funds?
Liquid funds are a category under mutual funds that invest primarily in money market instruments. Such instruments include certificate of deposits, treasury bills, commercial papers and term deposits, which usually have a residual maturity of up to 91 days.
The assets invested are not tied up for a long time and do not have a lock-in period. This means that an investor is free to pull out of it whenever s/he needs money upfront. The redemption is processed as quickly as in 24 hours.
Liquid funds have the lowest interest rate risk among debt funds as they primarily invest in fixed income securities with short maturity. In fact, these are considered to be the better short-term investment during high inflation, when the RBI keeps interest rates high and liquidity tight.
Despite all the benefits, one must keep in mind that returns are not guaranteed. The performance of any fund depends on how the market performs and the top-performing mutual funds are only an indicator of the returns. While one can safely assume that this rate will be better than savings account interest rates, this is where Fixed Deposite(FD) differ. They do not depend on the market.
Fixed Deposits (FD) have low liquidity till the tenure of the deposit ends. An investor has the option to make premature withdrawals but that usually comes at the expense of a penalty.
Moreover, as FDs come with a pre-specified return, they are immune to market conditions. Mutual funds, on the other hand, offer higher liquidity despite a minimum lock-in or holding period. There is an exit load if investments are withdrawn in a very short period, normally under a year. However, if the market conditions are good, mutual funds generate higher returns. They are also professionally managed. So, your hard earned money is in safe hands.
The key deciding factor between fixed deposits and mutual funds is tax. For FDs, tax levied depends on your current tax slab, irrespective of the term of the deposit. The tax on mutual funds largely depends on its category. Equity funds held for over a year are not taxable. Short term equity funds are taxable at 15 per cent. Long term debt fund gains are taxed at 20 per cent with indexation and 10 per cent without indexation. And short term capital gains are taxable according to investor’s tax slab. Therefore, it is evident that MFs are more tax friendly compared to FDs. The gains are the biggest on long term equity funds, which are not taxable at all.
Balanced Risk Approach
Generally, fixed deposits have minimal risk and are a safe bet for investors, but equity mutual funds carry higher market risks; Debt mutual funds on the other hand carry lower market risk than equity. Ideally, an investor needs to maintain a balanced portfolio, which comprises a mix of both fixed deposits and mutual funds.