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Thursday, May 25, 2017

Mutual Funds vs Fixed Deposits


When it comes to saving money, people often opt for fixed deposits (FD), considering them to be risk-free. The security of having money in the bank is apparently a significant factor and with FDs, it is highly unlikely that you will lose your money. However, with other factors at play, notably inflation and taxes, do FDs provide more bang for your buck?

Let us take a closer look at this phenomenon. You invest Rs. 10,000 in an FD for five years at an interest rate of 7.5% compounded every quarter (Most Indian banks offer 7-7.5%). After five years, the maturity value is 14,499 rupees. However, with an inflation rate of 5.8%, the purchasing power of 10,000 rupees has fallen. The interest on FDs are also taxable, the more one invests in FDs, the more tax one has to pay (on the returns). However, FDs give fixed rate of interest, and mutual fund schemes do not guarantee returns. With rising inflation, a fixed interest rate can seriously undermine the value of long-term investments.

In the case of Mutual Funds (MF), the scenario is a wee bit different. Although MFs are affected by market volatility and do have a level of risk depending on the portfolio, they seem like better options. During positive market conditions; MFs have the potential to earn high returns whereas FD rates are unaffected. Concerning risk; equity mutual funds carry high market risk, and debt mutual funds carry lower market risk than equity. Thus, an investor can design his portfolio based on his risk appetite, or even diversify to manage risks better. Besides, MFs are managed by professional fund managers, who do their best not only to protect investments but also to grow it.

Meanwhile, as the name suggests, FDs have a fixed period and have little liquidity till the tenure of the deposit ends. If you withdraw money from your FD prematurely, most banks will impose a penalty on the final amount.

In the case of MFs, most of them offer high liquidity on the condition that the minimum holding period has passed and subject to lock-in period as applicable. If the investment is withdrawn within a short duration (under a year), an exit load may be charged. Some MF schemes allow withdrawals at any given point of time, without any exit load or extra charges.    

A crucial factor to be considered before choosing between FDs and MFs should be the tax status.  When it comes to FDs, the tax levied is at the maximum rate depending on your current tax slab, irrespective of the tenure of the fixed deposit. On the other hand, the tax status of MFs depends on its category. Equity funds held for long term (more than a year) are not taxable. Short term equity funds are taxable at 15%. Long-term debt fund gains are taxable at 20% with indexation, and 10% without indexation and short-term capital gains are taxable according to investor's tax slab. Hence, we can say that MFs are tax friendly compared to FDs. Especially gains on long-term equity funds, which are not taxable at all.  

In the end, the decision to invest between an FD and an MF is based on the risk capacity and the horizon of the individual. When the economy is booming, MFs can give great returns, and when the markets are volatile, they can provide a secure platform that can help grow your money in the days to come.


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