Debt Mutual Fund vs Fixed Deposit
When it comes to low-risk investments in India, two popular options are Fixed Deposits (FDs) and Debt Mutual Funds. Both are popular among investors who wish to keep their money relatively safe while earning steady returns. While FDs and debt funds may look similar, they work very differently and choosing between them can be confusing.
What is a Fixed Deposit (FD)?
A Fixed Deposit is a financial instrument provided by banks and Non-Banking Financial Companies (NBFCs). You deposit a lump sum of money for a fixed period at a pre-determined interest rate.
- Fixed Amount: You know exactly how much money you will get back when the FD matures.
- Safety: It is considered a very safe investment option.
- Lock-In: Your money is locked for the chosen duration. However, premature withdrawal facility is offered and a penalty may be levied.
Advantages of FDs
You can opt to invest FDs for the below-mentioned reasons:
- You want guaranteed returns.
- You depend on interest income for daily expenses.
- You do not want to track the market.
What is a Debt Mutual Fund?
A Debt Mutual Fund is a pool of money collected from many investors. Professional fund managers invest this money into fixed-income securities like Government bonds, corporate bonds, treasury bills, and money market instruments.
- Market-Linked: The returns are not fixed. The returns depend on the performance of the bonds in the market.
- Variety: There are many types, such as Liquid Funds (for very short term), Short-Term Funds, and Gilt Funds (Government bonds).
- Professional Management: A fund manager decides where to invest to maximise returns while managing risk.
Advantages of Debt Mutual Funds
You can opt to invest debt mutual funds for the below-mentioned reasons:
- You want better liquidity without withdrawal penalties.
- You understand that returns can fluctuate slightly and are willing to take a small amount of risk.
- You are looking invest for a few weeks or months.
Key Differences between FD and Debt Mutual Funds
Some of the main differences between FDs and debt mutual funds are mentioned in the table below:
Feature | Debt Mutual Fund | Fixed Deposit |
Taxation | For new investments, taxed at income slab rates | Taxed at income slab rates |
Management | Active | Passive |
Liquidity | High | Low |
Risk | Low to moderate | Very low |
Returns | Market-linked | Guaranteed and fixed |
Detailed Comparison between Debt Mutual Funds and Fixed Deposits
Feature | Debt Mutual Fund | Fixed Deposit |
Taxation | Old Rule (BeforeApril 2023): You received a tax benefit called indexation if you held the fund for more than 3 years. This significantly lowered the tax. New Rule (After April 2023): Indexation benefits have been removed for most debt funds (where equity investment is less than 35%). The gains are now added to your income and taxed at your slab rate, just like FDs. | The interest you earn is added to your total annual income and taxed according to your Income Tax Slab. Banks also deduct TDS if the interest exceeds a certain limit. |
Risk | Credit Risk: The company issuing the bond might default on payment. Interest Rate Risk: Changes in RBI interest rates affect the fund’s value | The risk is minimal. |
Liquidity | They are highly liquid. You can sell your units on any working day. The money usually hits your bank account within one or two working days. Some funds (like Liquid Funds) even offer instant redemption up to a certain limit. | You can withdraw money before maturity, but the bank will usually charge a penalty. |
Returns | Returns fluctuate. If interest rates in the economy fall, the value of existing bonds rises, and debt funds may offer higher returns. However, if rates rise, debt fund returns can temporarily dip. | The interest rate is locked the moment you open the FD. |
Both Fixed Deposits and Debt Mutual Funds are low risk investment options. If safety is your only priority, you can invest in FDs. However, if you want flexibility, ease of withdrawal, and the potential for slightly better performance, Debt Mutual Funds are an efficient alternative.
FAQs on Debt Mutual Fund vs Fixed Deposit
- Can debt funds provide regular income?
Yes, a regular income can be earned from debt funds. In debt funds, the investors' money is invested in interest-earning securities like corporate deposits, bonds, etc. These securities are like certificates that carry an obligation on the part of the bond issuer to pay regular interest to the investors.
- Who should invest in fixed deposit?
Fixed Deposits (FD) is one of the best investment options for individuals who don’t want to take risk and are looking for stable returns.
- Is it safe to invest in debt fund?
On comparing with equity funds, it is safer to invest in debt funds. However, the risk parameter of debt funds varies depending on the type of debt fund and interest rate fluctuation.
- Which type of debt fund is most preferred?
Investing in short-term funds is a better option as it involves lower to moderate level of risk.
- How can I invest in debt funds?
You can invest directly in debt fund plans or you can invest in debt funds through an asset management company.
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