Fixed Deposit vs Mutual Funds: Which is better investment option?

Financial planning plays a pivotal role in one’s life. Choosing the right financial instruments is not an easy task. People generally get confused when it comes to making the right choice for their investments.

Through this blog, we shall be highlighting the features and giving Comparison between two of the investment options: Fixed Deposit and Mutual funds. This shall help you guide your way to decide which one suits your Financial portfolio.

Bank Fixed Deposits vs Mutual Funds: Which is better Investment option?

Let us consider both the investment alternatives one by one:

Bank Fixed Deposits 

Bank Fixed deposit or FD has been an all time favourite of Indians since past few decades. When it comes to investing your money,the first investment option that comes to our mind is putting our money in Bank Fixed deposits.

Bank fixed deposits have been the most reliable source to invest your money over the years. Whether you are planning your short term investments or long term investments, bank fixed deposits seems to be a preferred choice. This is a popular choice especially for the ones who hesitate to take any sort of risk.

So, Bank fixed deposits are best suited to conservative investors not willing to take any risk and just enjoy a fixed return over a period of time. The risk free nature and fixed returns on FDs are the 2 big factors that attract a large number of investors towards FDs. Some investors don’t look beyond FDs and are satisfied with a fixed interest they get on FDs.

Banks generally provide 7-8% interest per annum based on the choice and tenure of Fixed deposit. But, one major point to be kept in mind is that this interest rate is pre tax i.e. before deducting tax.

Fixed deposit interest is fully taxable in the hands of the investor. However, banks are authorised to the deduct TDS @ 10% in case FD interest exceeds Rs.10000 during a particular financial year. Your total interest on fixed deposit forms a part of your Total taxable income and the same is taxed as per Individual tax rates.

So,you cannot escape paying taxes on the interest income that you earn on money invested in Fixed deposits.

You can anyways get a Tax deduction under section 80 C if you invest in 5 year tax saving Fixed deposits.

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Further, FD is not an inflation beating instrument. In simple words, the interest rates that banks offer are pre tax. So, when you adjust tax from it, you are actually left with very less returns. Considering the high inflation rates and tax applicable on interest on FD, what you generally receive is quite less than what you were expecting.

Two simple formulas to analyse things in a better way:

  • Post tax returns = Pre tax returns *{(100 – Tax rate )/100}
  • Inflation adjusted interest rate  = Post tax rate – Inflation rate

Let us clarify this with the help of a simple example :

Example: If you have a Fixed deposit of Rs.100000 @ 8% interest and inflation rate is 6% p.a. This means you will get Rs.8000 interest which is fully taxable (if you fall in the taxable slabs). Now, if you fall in the highest tax bracket of say 30% , what you get in hand is Rs.5600. This is just an annual return of 5.6% that is even below the prevailing inflation rate.

So, basically you are not getting enough returns even to meet the rising cost of inflation.

However, times are changing and investors are moving towards other investment options looking at the better returns they offer. One such investment option is investing in Mutual funds.

FD or mutual fund, FD vs mutual funds, fixed deposits, mutual funds

Mutual funds:

Mutual fund refers to the money pooled in by various investors to invest it in securities like stocks, money market instruments or bonds etc. These are managed by professional fund managers.

Mutual funds are subject to market risk. You need to be careful and read all the offer documents carefully while investing in any kind of mutual funds. This is a major point which restricts safe investors to invest in it. You cannot predict the markets.

Debt mutual funds are generally considered a safer option as compared to Equity funds. The underlying asset in equity funds is equity, so these carry a higher risk.

Also, looking at the historical data,mutual funds tend to perform better, if you invest your money for longer periods. But, past results are not any guarantee to future returns.

Mutual funds are generally considered inflation beating instruments. Mutual funds help you get better inflation adjusted returns as compared to fixed deposits in the long run. So, Mutual funds are an ideal investment option for the ones who have a wider risk horizon and are planning their long term investments.

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Moreover, mutual funds are more tax efficient than fixed deposits. So, if you fall in a higher tax bracket say 20% or 30% then mutual funds will prove to be a better tax saving option.

Simply stated, FD interest shall be taxable at higher tax rate say 30% (if you are in higher tax slab)as applicable to individuals. But, in case of mutual funds,the taxability arises when you will redeem or sell the mutual fund units. Further, the taxability is based on type of funds and the period of holding of mutual funds.

Go through the below table to know How mutual funds are taxed in India:

Tax on Mutual Funds

Period of Holding
Tax rate
Equity funds :
STCG - Short term Capital Gain
MF units held for less than 1 year
LTCG - Long term Capital Gain
MF units held for > 1 year
Taxable @ 10% where LTCG>1 lakh (No indexation benefit) : As per amendment in Budget 2018
Non-Equity funds
STCG - Short term Capital Gain
MF units held for less than 3 years
As per Individual tax slab rates
LTCG - Long term Capital Gain
MF units held for > 3 years
20% (with indexation)

So, you can easily analyse that mutual funds emerge as a clear winner when it comes to better tax saving options in India.

SIP or Systematic Investment Plan is a good way to invest in mutual funds. For additional details on SIP you can refer: What is SIP ? What are its benefits?

To understand it further, we have given the Comparison between Fixed deposits and Mutual funds in tabular form as well. This will make easier for you to analyse and decide Which is better investment option: Fixed Deposits or Mutual funds.

Comparison: Bank Fixed Deposits or Mutual Funds

FactorsFixed DepositsMutual funds
ReturnsYou get fixed returns over a period of time.No fixed returns are guaranteed in case of mutual funds.
RiskFDs are risk free in nature.Risk is involved since returns are based on market fluctuations.
InflationFDs are not inflation beating instruments.Mutual funds tend to beat inflation in the long run.
Capital gainNo Capital gain or loss in case of FD.Capital gain or loss arises based on the period of holding.
TaxInterest on FD is taxed as per individual slab rates.STCG or LTCG taxed as per type of fund and period of holding.
Returns potentialYou will get a fixed rate of interest as per your type of FD and period of FD.No chances of getting higher rates than what has been defined.Mutual funds have the potential to give high returns through diversification of your money.
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To conclude, the choice between Fixed deposits or mutual funds is primarily based on few important facts like:

  • You are a safe player or you are ready to bear some risk.
  • You are looking for risk free investment options or riskier ones.
  • You want fixed and guaranteed returns or you want variable/higher returns.
  • Higher the risk, higher returns you can expect but subject to market fluctuations.
  • You are satisfied with nominal returns or you want to explore different investment options generating higher returns.

Our age also plays an important role here. When we are are young,we can afford high risk. But, as we grow in years, we get inclined towards secure investments. That is quite normal and also the correct way.

Hence, keeping in mind all the differences between fixed deposits and mutual funds, you can take your own decision as what suits you the best.

If you are interested in mutual funds, you can go through our list of 7 Best Books on Mutual Fund Investing!

Now, Where you want to invest, in fixed deposits or mutual funds or both? How much to invest? The final decision is yours!

Diversification is the key to get good returns. So, it would be wise if you keep some of your money in Fixed deposits and diversify the rest in other investment options like mutual funds.

Which one do you like: Fixed deposits or Mutual funds? Would love to hear your valuable feedback on the same! If you have any additional points that might help some investors, please feel free to share in the comments section.

1 thought on “Fixed Deposit vs Mutual Funds: Which is better investment option?”

  1. Hi,Thanks for the nice post!!!
    Clearly, debt funds are a better choice over fixed deposits in terms of taxation if the investment is for over 3 years or you plan to use the money in parts.As you pointed out, debt funds carry greater risk.However, a much bigger issue is selecting the right kind of funds. Since many focus on just the past returns (as in case of equity funds), it can be a big problem in debt funds especially if you catch the wrong end of interest rate cycle.
    I am not arguing against debt funds. All I am saying is that it is not difficult to pick up a wrong debt fund.So,one needs to be cautious in selecting it.


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