Fixed Deposits vs Mutual Funds: Which One to Choose?

Both Fixed Deposits (FDs) and Mutual Funds are popular investment instruments in India. While FDs are a popular choice due to their safety and reliability, mutual funds have emerged as a promising alternative in recent years. With changing times, it's essential to explore different and better investment avenues for a risk free and high returns.

In this blog, we will dive into the world of FD vs mutual funds, comparing their returns, risks, expenses, withdrawal terms, taxation, investment modes, and their impact on inflation. 

Fixed Deposits vs Mutual Funds: A Comprehensive Comparison

1. Returns

To choose between fixed deposits vs mutual funds, one of the primary things to consider is the returns, here’s a quick breakdown: 

Fixed Deposits: FDs offer guaranteed returns at a predetermined rate over a specific time period. This makes them an attractive option for conservative investors seeking stability.

Mutual Funds: On the other hand, mutual fund returns are linked to the financial markets and the securities they invest in. As a result, these returns vary based on market conditions. While they may offer higher returns compared to FDs, they also come with greater volatility.

2. Risks

It’s important to weigh the risk factors while exploring the right option between fixed deposits vs mutual funds: 

Fixed Deposits: FDs are considered low-risk instruments as they provide pre-determined returns. The risk involved is minimal since investors know exactly how much they will earn at the end of the tenure. Additionally, investments up to ₹5 lakh per depositor, per bank under DICGC.

Mutual Funds: Mutual funds, on the other hand carry higher risk. Since they are subject to market volatility, the returns can fluctuate based on the performance of the investments made by the fund manager. It's important to note that different mutual funds carry varying levels of risk.

3. Expenses

The expenses include: 

Fixed Deposits: When it comes to FDs, there are no charges involved during the initiation or the tenure of the deposit. The interest earned is usually credited directly to your account.

Mutual Funds: Mutual funds are associated with certain expenses, such as fund management charges and administrative fees (expense ratio). These charges may vary depending on the type of mutual fund and the asset management company overseeing it.

4. Withdrawal

Another important aspect to consider is the lock-in period:

Fixed Deposits: FDs (callable FDs) don’t come with any lock-in period and allow pre-mature withdrawal. However, you may have to pay a penalty fee, usually 1% interest. Also, you’ll be eligible for the interest rate as applicable on the date of withdrawal and not the promised rate. 

Mutual Funds: Investors can withdraw their mutual fund investments (except ELSS funds where the lock-in period is 3 years) after a certain period without any charges. However, mutual found houses or Asset Management Companies (AMCs) may impose exit load – a minor percentage of the value of mutual fund units redeemed – in case you opt for premature redemption. The percentage varies from scheme to scheme, but is usually capped around 1%.

5. Taxation

Both FDs and mutual funds are subject to taxation:

Fixed Deposits: The interest earned from fixed deposits is taxed based on your income slab. TDS (Tax Deducted at Source) of 10% is applicable provided the interest income is more than ₹50,000 (₹1 lakh for senior citizens) in a financial year. Please note that the TDS exemption limit is for FY 2025-26. For FY2024-25, the TDS exemption limits on FD interest are ₹40,000 for regular citizens and ₹50,000 for senior citizens.

Mutual Funds: Taxation in mutual funds depends on various factors such as the type of mutual fund (equity-oriented or debt-oriented) and the holding period. Long-term Capital Gains (LTCG) tax is applicable if the holding period exceeds 12 months. Short-term Capital Gains (STCG) tax is applicable if the holding period is up to 12 months. Debt funds are subject to different tax rates. 

For equity mutual funds, 20% STCG would be imposed. If the holding period is more than 1 year, LTCG of 12.50% without indexation benefits would be imposed.

6. Investment Mode

Determining the mode of investment gives you the liberty to opt for the better investment option based on your flexibility:

Fixed Deposits: When it comes to FDs, investors can only opt for lump-sum investments. This means you need to have a substantial amount of money ready to be invested.

Mutual Funds: Mutual funds offer the flexibility of both lump-sum and systematic investment plan (SIP) modes. With SIP, you can invest smaller amounts at regular intervals, making it easier to start investing with as little as ₹500.