Mutual Funds vs Fixed Deposits: Choosing the Right Option for Your Goals

The interest rates for FDs are fixed at the time of deposit. For example, an FD may offer a 6.5% annual return for a 3-year deposit, whereas a mutual fund could deliver 12% annualised returns over the same period in an equity-focused scheme.

Risk and returns

Unlike mutual funds, FDs are not influenced by market fluctuations, making them low-risk investments. They work best for conservative investors who prioritise capital protection over growth. In contrast, mutual funds carry varying levels of market risk depending on the underlying assets. This makes FDs ideal for conservative investors while mutual funds are more suited for investors with a higher risk appetite who can handle short-term volatility for long-term growth. For example, if you invest ₹2 lakh in an FD, you will receive the agreed interest on maturity. However, a mutual fund investment of the same amount can grow or decline in value, based on market conditions. FDs offer fixed returns and are ideal for short-term financial goals. Mutual funds, on the other hand, can provide higher, but not guaranteed, inflation-beating returns over the long term. For instance, a ₹5 lakh FD at 7% interest will grow to ₹6.17 lakh in three years. An equity mutual fund offering an average rate of 12% could grow your
investment to ₹7.05 lakh over the same period. Costs FDs are cost-free investments where money is deposited and accumulates interest over the FDs tenure. Mutual funds, however, come with an expense ratio-a nominal fee for managing the fund- typically up to 2% annually.

Tax treatment

Interest earned on FDs is added to your total income and taxed according to your income tax slab. TDS (Tax Deducted at Source)
applies if the interest exceeds ₹40,000 in a year (₹50,000 for senior citizens). Tax-saving FDs allow you to claim deductions while earning returns.

Mutual funds are taxed based on their type and holding period. Equity funds held for over one year are subject to a 10% Long-Term Capital Gains (LTCG) tax if gains exceed ₹1 lakh, while short-term gains are taxed at 15%. For debt funds, LTCG attracts a 20% tax with indexation benefits after three years, and short-term gains are taxed as per your slab rate.

Loan against FDs and mutual funds

You can avail of a loan against FDs or mutual funds to meet sudden financial needs, avoiding premature liquidation of your investments. Banks allow you to borrow up to 90% of your FD value at an interest rate 1-2% higher than the FD rate. The process is quick and straightforward, with minimal documentation. Similarly, you can pledge mutual fund units to secure a loan. The loan amount depends on the fund’s current value, typically up to 50-70% of the portfolio. These loans let you retain ownership of your investments, which continue to earn returns or dividends.

FDs or mutual funds – Which one to choose?

Both mutual funds and fixed deposits serve different purposes and can coexist in your portfolio to cater to varying financial goals and needs. FDs provide capital safety and assured returns, while mutual funds offer growth and inflation-beating returns. FDs are highly liquid, allowing early withdrawals with a nominal penalty. Mutual funds are easy to buy and sell, offering flexibility to adapt to your changing needs. With both investments offering unique benefits, the choice to pick either or both of them should ideally be made depending on your financial goals, risk tolerance, and investment horizon.

Adhil Shetty, CEO, BankBazaar.com