How safe are mutual funds as compared to FDs?

  • Posted By : reliancesmartmoney.com
  • Monday Sep 11, 2017

Key Takeaways

  • MFs provide inflation-adjusted returns
  • MFs are highly liquid than FDs with lower min. investment period and lower fee of exit
  • MFs allow diversification between different sectors or kinds of funds depending on risk appetite

As investors we want our savings to amplify and will try every alternative to fulfil this quest. Of late numerous investment options are made available each claiming to furnish assured returns on money and so it becomes important to choose the best option. Let’s discuss two investment choices, Mutual Funds and Fixed Deposits, and see if Mutual Funds can be a safer option over Fixed Deposits while optimizing returns.

Fixed Deposits

FD is considered as the safest form of investment that provides fixed returns. Usually banks offer an interest rate from 6% to 9% or higher mostly depending on the tenure chosen and the current market conditions. Generally, longer durations reap higher interest rates. These rates do not change with inflation making them low inflation-adjusted return generator. Obviously, being secure, they are associated with low risks and are most suitable for investors who are risk averse or senior citizens. Another key facet of this investment category is that there is no management cost (investment fee) involved during its initiation. Furthermore, banks are now recommending several diverse types of FDs like Tax Saver FDs, Flexi FDs, among others with enhanced features which suit the investor’s need effectively.

While we understand the reasons that make FDs an upbeat investment choice, it is also crucial we become aware of the downbeats associated with it.

  • The profit gained over the principal amount is taxable under your regular income tax slab. Considering you fall under the highest tax slab of 30%, this can mean significant loss in return capital.
  • These investments offer low to medium liquidity (the rate at which investments are converted into cash). With some percentage of penalties, premature withdrawal is possible (the loss incurred here is a summation of reduced interest rate associated with shorter term and penalty percentage).
  • Since it doesn’t tag along with the market movements, it can limit the return rate during positive market scenarios.

Mutual Funds

These investment strategies aid higher risk levels with larger return values. Mutual funds are much more flexible in their workings when compared to the straight-forward bank-offered FDs. These are classified into Debt Mutual Funds and Equity Mutual Funds. While Debt MFs invest in corporate bonds and government securities, Equity MF invests capital in the share market.

High-merit Features

  • Mutual Funds have the capacity to beat inflation and provide inflation-adjusted returns. While they do not guarantee any specific interest rate, they can provide high capital appreciation during positive market conditions.
  • They are highly liquid after the completion of their minimum investment holding period. With approximately 1% (value may vary depending on the fund house) exit load i.e. the fee charged for exiting a MF scheme, the financier can withdraw his investment.
  • Taxation is the major criteria which beats FDs. While long-term interest gained on equity mutual funds is completely tax-exempted, short-term gains are taxable at 15%. In debt mutual funds, short-term gains are taxable under the normal income tax-slab of the investor and long-term gains are taxable at 20% (with indexation) and 10% (without indexation). Long-term implies to investment tenure of over a year.
  • Another good feature provided by mutual funds is diversification. While trading in equity, an investor can diversify between different sectors (infrastructure, IT, pharma, etc.) or between different stock caps (large-cap, mid-cap, or small-cap) for promising returns. Another aspect is diversifying between different mutual funds (investing small percentages separately in debt, equity or balanced). Furthermore, diversification can happen at an asset management company level, meaning one can choose from several reputed fund houses and invest some amount with each.

Minimal-Level Drawbacks

  • In addition to higher risks and no fixed returns, one disadvantage associated with mutual funds in comparison to FDs is the investment fee. While initiating a mutual fund, depending on the fund type, the investor has to pay some management cost. This can be 1% for a liquid fund, 0.5% to 2.25% for a debt fund while 3% for equity fund.

Besides Equity and Debt Mutual Funds, there is a third category called Balanced Mutual Fund which incorporates benefits of both Equity and Debt. This MF invests in equity and bonds in a pre-defined ratio thereby balancing out the risk-level to moderate with potentially larger returns than FDs.

With so many flexible features, Mutual Fund Investments are safer and more promising than traditional Fixed Deposits. Nonetheless, as an investor, it is crucial to answer these three most central questions for building the most fitting investment portfolio for yourself.

  • What is your Financial Aim?
  • How big is your Risk Appetite?
  • What are your Expected Returns?
Happy Investing!

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