Thursday, 22 October 2015

Mutual Funds vs Fixed Deposits; which one to choose?

When it comes to saving money, people often opt for fixed deposits, considering them to be relatively risk free.  The security of having the money in the bank is apparently a great factor. But we need to introspect that is this actually saving of money or rather losing of it?

Fixed deposits of FDs may give attractive returns on paper, but with the tax payable at the current tax slab, the more one invests in FDs, the more tax one has to pay. Taking in consideration the rate of inflation over the years, it is possible that one may actually be facing a loss by investing in FDs.
In the case of Mutual Funds or MFs, the scenario is a wee bit different.. Although MFs are affected by market volatility and do have a level of risk, they are managed by professional fund managers, who do their best  not only to protect investments but also to grow it.

When it comes to rate of returns, FD rates are pre-specified and do not change for the entire tenure. On the other hand MF rates are affected by market conditions, hence during positive market conditions; MFs have the potential to earn high returns where as FD rates are unaffected.
In terms of risk, FDs are generally known for minimal risk, where as equity mutual funds carry high market risk, and debt mutual funds carry lower market risk than equity. But risks can be mitigated to a certain extent as MFs are managed by professionals.

Yet, MFS are prone to market risk. But as it is said, big risks give big returns.

FDs have a fixed time period as the name suggests, and generally have low liquidity till the tenure of the deposit ends. In 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.  In case of premature withdrawals, FD holders have to pay a penalty, and miss out on a portion of the expected returns. MFs only charge an exit load if investments are withdrawn, in a very short period, normally under a year. Some MF Schemes  offer high liquidity. Funds can be withdrawn at any given point of time, without any exit load or extra charges.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, tax levied depends on your current tax slab, irrespective of the tenure of the fixed deposit. Instead 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 a FD and a MF is based on the risk capacity, and the horizon of the individual. But when the things are hopeful, and there are good prospects for growth of the economy, it makes greater sense to invest in MF, because of the possibility of returns.   

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