For conservative investors looking to grow their wealth with low risk, two probable investment avenues are fixed deposits (FDs) and debt funds. Both of these investment tools offer potential benefits – with debt funds promising comparatively higher returns over an extended period and fixed deposits offering stability in return for gains. So, which one should you choose?
Understanding parameters like liquidity, ease of investment, risks and returns, taxation, etc., can help you compare them and make an informed decision about where your money is most suitably invested for your personal financial goals. With that being said, let’s take a closer look at the features, benefits, and limitations associated with both instruments.
Understand debt funds
Debt funds are mutual funds that invest in debt securities such as government bonds, corporate bonds, treasury bills, commercial paper (CP), and certificates of deposit (CD). They are typically managed by professional fund managers who monitor the market conditions and choose debt securities accordingly.
Features and advantages of debt funds
- Low risk – Since debt funds invest in fixed-income instruments, they are considered to be lower risk than other types of investments, such as equity mutual funds.
- Diversification – Debt funds enable investors to diversify their investments by investing in multiple securities at once. This helps reduce overall risk and provides the potential for decent returns over time.
- Liquidity – There are many debt fund types that offer high liquidity and levy no exit load. So, you can sell them quickly if there is a need for immediate funds.
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Understanding fixed deposits
Fixed deposits refer to deposits made with a financial institution for a predetermined amount of time with a specific interest rate attached to them.
Features and benefits of fixed deposits
- Guaranteed returns – FDs offer guaranteed returns, making them attractive to conservative investors who want predictable returns on their investments.
- Flexibility – You can choose the tenure for your FDs, depending on the amount being invested and the particular bank.
- Safety of funds – Fixed deposits offer security as they are backed by DICGC (Deposit Insurance and Credit Guarantee Corporation) up to 5 lakhs per depositor.
Comparison of debt funds and fixed deposits
- Tax implications
Short-term capital gains through debt mutual funds are taxed at applicable slab rates; however, long-term capital gains are taxed at 20% after indexation benefits. Fixed deposits have no indexation benefits, and tax is applicable as per your slab rate every year.
- Risk factor
With debt funds, there is risk associated with them due to market fluctuations or changes in interest rates, which can affect the performance of these investments over time.
FD returns are not market-linked. There may be penalties associated with early withdrawals or which could result in losing some or all of your deposited money. Additionally, due to inflationary pressures over time, the returns on fixed deposits may not keep pace with rising prices which could impact its purchasing power over time.
- Ease of investment
Investment through fixed deposits requires a lump sum amount upfront. However, debt mutual fund investments can be made through systematic investment plans and lump sum modes. SIP investment is an effective way to automate your savings and manage the market’s volatility by making systematic contributions each month (or at the frequency you choose).
A thorough evaluation of your financial position, investment horizon, and objectives should help you make a better decision when selecting between a debt fund or FD for an investment avenue. With adequate research and planning for both long-term wealth-building goals and short-term emergency needs, either can be a key component in any financial portfolio.