Fixed Deposit (FD) is a financial instrument provided by banks and corporate houses which provides investors with a fixed rate of interest, which is usually higher than a regular savings account, until the pre-specified maturity date.
Mutual Funds (equity and debt) and FDs are both very favored financial instruments. A brief comparison of the instruments are as below:
| Equity Mutual Funds | Debt Mutual Funds | Fixed Deposits | |
|---|---|---|---|
| Returns | Market-linked returns (12% – 15%) | Relatively stable returns (7% – 9%) | Fixed returns (7% – 9%) |
| Risk | Higher risk | Low/ negligible risk | Safe instruments |
| Tax on investment | ELSS investments are tax deductible u/s 80C | NA | Investments in 5-year tax saver FDs are tax deductible u/s 80C |
| Tax on redemption |
|
|
Interest is taxable at the investors’ tax slab. No tax on principal portion of FD. |
| Lock-in | No lock-in | No lock-in | Lock-in according to the FD |
| Premature withdrawal | Allowed with exit load | Allowed with exit load | Allowed with penalty |
*We have assumed average returns of the last 10 years
Though equity mutual funds give higher returns in the long term, but if the investor’s primary objective is capital protection and regular income stream, debt mutual funds and FDs are more suitable.
Within fixed income instruments, if an investor wants to keep his funds invested for less than 3 years, FDs may offer slightly higher returns but lack the liquidity provided by debt funds. However, beyond 3 years, the marginal excess returns in FDs are offset by higher taxation. This makes debt funds better as they are taxed at 20% after indexation benefit.
Thus, the investor should assess his risk appetite, investment time horizon and income requirements, among other factors and then invest.
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