We often come across the question, are mutual funds better than fixed deposits? The answer is a definitive yes. But it also depends on your investment horizon. If you are saving for the long term, mutual funds are definitely better than fixed deposits.
The size of Fixed Deposits held by Commercial Banks in India is INR 95 lac crore as the time this article ( March 2019) is being written. The Assets under Management of Mutual Fund Industry in India at the same time is about 14 lac crore. This means that most Indians Invest in Bank Fixed Deposits to save and grow their money.
We are living in a time where interest rates are constantly reducing. It is not possible to get the high returns which we used to get on Bank FDs a few years ago. Banks typically pay around 7 percent on deposits held for 1 year or more. The interest rate offered to senior citizens is a little higher. The interest earned on your Bank Fixed Deposits is subject to TDS @ 10%. This means you earn around 6.5% per annum on such deposits.
Mutual Funds can give you much better returns as compared to fixed deposits of the same tenure. The type of Mutual Fund scheme that you should invest in, depends on your Investment objective, tenure of Investment and several other factors.
Equity based Mutual Funds have typically earned 12% CAGR (Compounded Annual Growth Rate) or more over the last decade or two. Debt based Mutual Funds currently earn around 8% per annum or more depending on the type of scheme that you choose. Investors can also opt for Fixed Maturity Plans (Close Ended Mutual Fund schemes) to invest for 3-5 years. Investors also have the option to invest in balanced schemes, which have a combination of Equity and Debt based portfolio. Although past performance is not a guarantee of future returns, the probability is reasonably good. Update: the tax treatment described when this article was first written no longer applies. Dividends from mutual funds are taxed in the hands of the investor at their income tax slab rate (Dividend Distribution Tax was abolished from FY 2020-21). Profits on equity mutual funds held over 12 months are no longer tax-free — since Budget 2024, long-term gains above Rs. 1.25 lakh a year are taxed at 12.5%, and short-term gains (under 12 months) are taxed at 20%. Profits on debt-based mutual fund units remain subject to tax, and for units bought on or after 1 April 2023, all gains are taxed at your income tax slab rate regardless of holding period, with no indexation benefit.
Mutual Funds also allow you the flexibility of investing a fixed sum every month (like a Recurring Deposit with a Bank). This is called a Systematic Investment Plan (SIP). SIPs help to cultivate the habit of savings and also cultivate Investment discipline. It also helps to average out the cost of purchasing Mutual Fund units as you get more units when the stock prices are low and less units when the stock prices are high. Moreover, Mutual Funds also allow you to withdraw your investments systematically over a period of time. This feature is called a SWP (Systematic Withdrawal Plan).In developed counties like USA and UK, etc. the Assets under Management of the Mutual Fund Industry vis a vis Bank Deposits is much higher than in India. As Indians become more aware of the advantages of Mutual Fund Investments and lay aside their fear of investing in Mutual Funds the Assets under Management of Mutual Fund Industry will steadily increase. The difference between Investments held by Banks as FDs and Assets under Management of the Mutual Fund Industry has to decrease over the next decade or two. As the percentage of educated class of people increases in Indian society, the size of the Mutual Fund industry will keep on increasing.
Article Originally Written in March 2019.
Related reading: why people still invest in fixed deposits and life insurance, and mutual fund taxation explained.
