Bank fixed deposits are a traditional investment option for most Indian households. Debt mutual fund investment plan, on the other hand, have also grown in popularity due to their higher returns and liquidity features than bank fixed deposits.
Here is comparative analysis between FD and debt mutual fund to assist retail investors make an informed choice:
- Capital protection
A fixed deposit through scheduled banks is backed by an insurance program offered by the DICGC, a subsidiary of the Reserve Bank of India. This insurance scheme ensures to cover every depositor for deposits of up to Rs. 5 lakh in the occasion of bank failure. The insurance covers both the interest and principal components of not just FD but also of savings, recurring and current deposits. Remember that for those having deposit accounts in multiple banks, the cover of Rs. 5 lakh would apply separately to deposits of each of the banks. This specific feature makes FD a safe investment choice.
On the contrary, debt mutual funds in India do not assure capital protection. As it is an underlying security, which is traded in debt markets, it is susceptible to capital erosion. Interest rate risk and credit rate risk are 2main risks of investing in debt funds. Credit rate risk is the default in the interest or principal repayments by the issuers of the underlying securities. Investors can lower this risk by investing in debt funds having highest rated corporate debt instruments or increased exposure to sovereign debt. The interest rate risk is the market value erosion of debt mutual fund investments owing to high policy rates of the Central Bank. The risk can be higher in debt funds having longer maturity profiles of underlying debt securities. Investors can lower this risk by choosing debt mutual funds with reduced maturity profiles like overnight, liquid, low duration, short duration, and ultra-short duration debt mutual funds.
Applicable rate of interest when opening the fixed deposit stays fixed until its maturity irrespective of any change on the card rate during the investment interim. For instance, if X opens a fixed deposit of 4 years at 6 percent p.a., the interest rate will stay fixed at 6 percent p.a. until the 4 year investment tenure ends. It offers a high amount of income certainty for the fixed deposit, which is higher as compared to most of the small savings’ schemes.
Returns on debt mutual funds are the sum of capital appreciation of the underlying securities and their interest income. Capital appreciation of debt securities basically is dependent upon various parameters including policy rate changes and credit rating changes of underlying securities. It lowers the income certainty from debt mutual funds. However, because debt mutual funds generally invest a good portion of their corpus in the market associated with fixed income investments, if the right selection of debt funds is done, it has the potential to generate higher returns as compared to FD.
Besides tax saving fixed deposits, most FDs permit premature withdrawal. Banks generally charge a premature withdrawal penalty of up to 1%. This withdrawal penalty is deducted from the FD’s effective interest rate.
For debt funds, on the other hand, except for fixed maturity plans, retail investors are free to liquidate their debt mutual funds at any time. However, few debt mutual funds might charge exit load on liquidation before a predetermined timeline. Debt mutual funds that belong to liquid, ultra-short and overnight categories do not charge exit load. This makes debt funds a prudent investment option to meet your short term crucial financial goals or build an emergency fund.