Mutual Funds and Fixed Deposits (FD) are two of the most popular investment instruments. But they differ significantly in terms of risk, returns, and liquidity. While an FD promises a fixed return, we all know that – Mutual Fund investments are subject to market risks – which is why we must – read all scheme related documents carefully before investing!
To help you make an informed investment decision, the salient features of both these instruments have been discussed below.
A fixed deposit is an investment instrument that allows you to deposit a lump sum amount for a fixed tenure. Your money will accrue a fixed rate of interest over this period, and this rate is predetermined at the time of investment. Market factors do not affect the interest rate, and at the end of the tenure, you get your money back along with the promised interest.
Fixed deposits are a tried and tested investment option. In fact, older generations particularly prefer fixed deposits since money locked away in a bank imparts a sense of comfort. However, if you wish to withdraw your money before maturity, the bank will charge a penalty, which could be anywhere between 0.5% to 1% of the total amount. Also, they will adjust the interest component. For instance, if you liquidate a 5-year FD in its second year, the interest will be calculated as per the interest rate of a 2-year FD.
In a mutual fund, a group of investors come together and invest in equity, debt instruments, or a combination of both. The returns earned are then distributed among the investors after the fund manager deducts a fee to cover all the expenses incurred.
In the case of mutual funds, market forces determine the rate of return, and therefore, returns are not guaranteed, fixed, or uniform. The returns associated with mutual funds are high, but so is the risk. And as far as liquidity is concerned, different mutual fund instruments have different lock-in periods. Some liquid mutual funds have no lock-in period at all.
While fixed deposits are somewhat safer than mutual funds, the tax-adjusted rate of return on FDs barely surpasses the rate of inflation. Therefore, the decision between a mutual fund and fixed deposit depends entirely on your risk appetite. If you are averse to risk, and want assured returns, you should go for a fixed deposit. But if you are comfortable with a moderate amount of risk, mutual funds can give you desirable returns.