Fixed deposits and mutual funds are the two most preferred investment instruments today. Both outperform savings bank interest rates and reward investors in the short-to-medium term. However, investors can be hard pressed to choose from among the two. After all, these investment categories come with distinct advantages and disadvantages. Here is a simple guide to help you make an informed decision.
Fixed deposits, as the name suggests, are traditional investment instruments offered by banks. They offer a fixed rate of interest for a pre-specified tenure. Fixed deposits are considered to be safe investments.
Mutual funds, on the other hand, carry relatively higher risk. Their performance is highly dependent on market conditions. This is why all mutual fund scheme advertisements mandatorily carry disclaimer-that investments are subject to market risk. Mutual funds are broadly classified into
- equity mutual funds, where the risks are higher, and
- debt mutual funds, where the risk is lower and so is the return.
Advantages and disadvantages
Fixed deposits have low liquidity till the pre-specified tenure of the deposit ends. An investor can opt for premature withdrawals, but not without paying a penalty. If that be the case, the investor also loses out on a part of the expected returns. Fixed deposits come with a pre-specified return. They are immune to market conditions, which works in their favour.
Mutual funds, on the other hand, offer higher liquidity. But there is a pre-condition. The minimum holding period must pass and a lock-in period may apply. Mutual funds only charge an exit load if investments are withdrawn in less than a year. But if the market conditions are good, mutual funds have an advantage. They generate higher returns for the investor. Mutual funds are also managed by professionals. This means your hard-earned money is in safe hands.
Why liquid mutual funds can be a good option
A liquid fund is a category of mutual fund that invests primarily in money market instruments. This includes certificates of deposit, treasury bills, commercial papers, and term deposits.
These funds invest in securities with a residual maturity of up to 91 days. The assets invested are not tied up for a long time. They also do not have a lock-in period. So, an investor can pull out of it whenever he/she feels there is a need of cash. The redemption is processed within 24 hours. This is a big plus during stressed times.
Company fixed deposits
Company fixed deposits sometimes offer better interest rates than bank fixed deposits. But an investor must do some research on the company before investing in such fixed deposits. The rating of the company is something the investor should watch out for. The rating indicates credit worthiness. Ideally, investors should pick companies with AAA ratings. Other issues like the repayment history of the company should also be considered.
The key deciding factor when choosing between fixed deposits and mutual funds should be tax. When it comes to fixed deposits, the tax levied depends on your current tax slab, irrespective of the term of the deposit. The tax status of 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%. Long-term debt fund gains are taxed at 20% with indexation and 10% without indexation. Meanwhile, short-term capital gains are taxable according to the investor’s tax slab. So, mutual funds are more tax-friendly than fixed deposits. The gains are the biggest on long-term equity funds, which are not taxable at all.
Consider your risk appetite, investment time horizon, and your return expectation while choosing between fixed deposits and mutual funds. Generally, fixed deposits have minimal risk and are a safe bet for investors. Equity mutual funds carry high market risk. Meanwhile, debt mutual funds carry lower market risk than equity. So, why not have both in your portfolio. After all, both are considered to be good investment instruments.