Fixed Deposits vs Debt Funds: Which is a better investment option?

Fixed Deposits vs Debt Funds: Which one to choose between the two?

FDs vs Debt Mutual Funds

Bank Fixed Deposits in India are considered to be one of the safest instruments for investment. After all, they promise you a fixed rate of return along with the safety of your capital. Not many people know that they could lose their FD money in the event of bank going bust. However, the probability of a bank getting closed down is very low/nil if it is a Nationalised Bank.

An alternative to Fixed Deposit is Debt Mutual Fund, which is also one of the popular investment tool for the investors due to its lower tax implications.

In the article below, I shall compare Fixed Deposits and Debt Mutual Funds on various parameters.


1. Premature withdrawal/ Liquidity

Both Fixed Deposits and Debt Mutual Funds give you the option of partial/complete withdrawal subject to varied implications on the amount withdrawn.

Fixed Deposits:

As the name suggests, your money will be locked for a fixed duration opted by you. However, if you want to withdraw your money for any reason, then banks does provide you with the option of breaking your FDs in part/full, remember not all banks give you the option of partial withdrawal. In most of the banks, you have to withdraw the entire amount.

For instance, ICICI Bank allows premature withdrawals in multiples of Rs. 1,000 subject to applicable charges. HDFC Bank, on the other hand, does not allow for premature withdrawals of term deposits booked under preferential rates. Also, you may end up paying a penalty of 0.5% – 1% on the applicable interest rate for the actual duration FD was held. So for instance, you have opened an FD of 390 days with an interest rate of 7.5%. Later, you decided to break the FD in 6 months, and the applicable interest rate for a six-month FD is 6.8%, then the interest paid on the withdrawal amount will be between 5.8% – 6.3% after deducting the penalty of 0.5% – 1%.

Debt Mutual Funds:

Debt Mutual Funds give you the option for withdrawal of any amount at any time from your investment corpus. However, some of the funds may charge an exit load of 0.25% – 1% on the withdrawal amount, if the funds are withdrawn before a specified period. Usually, the term is one year or less than that, from the date of investment.

Note: There is no exit load on the withdrawal of Liquid Funds.

2. Tax Implication

• On Capital Gains

Fixed Deposits:

In case of FDs, capital gains does not come into picture. Instead, you earn interest on your principal amount based on the term of deposit as well as frequency of interest payout, you will be liable to pay taxes on the interest earned as per your income tax slab.

Debt Mutual Funds:

You have to pay taxes at the time of sale or redemption of Debt fund units if you have opted for Growth Option. In other words, you have to pay tax on the gains/profit earned at the redemption of your money. If you hold your money for less than or equal to three years, the gains will be termed as short-term capital gains, and if you keep your money invested for more than three years, gains will be treated as long-term capital gains.

In case of short-term capital gains, the tax will be levied as per your income tax slab. On the other hand, for long-term capital gains, the tax will be charged at 20% after indexation. The indexation lowers the tax liability.

• On TDS

Fixed Deposits:

TDS is deducted by the banks at the rate of 10% (excluding cess and surcharge) if the yearly interest exceeds Rs. 10,000, in case of PAN submission. If PAN is not submitted, banks will deduct TDS at flat 20% (excluding cess and surcharge).

So for instance, you have earned an interest of Rs. 9,000 during a financial year on your FD, the bank will not deduct the TDS. But, if you have earned an interest of 15,000 in a year, the bank w ill deduct TDS at 10% on Rs. 15,000 i.e. Rs. 1,500 in case you have submitted your PAN with the bank. If you have not submitted your PAN, TDS amount will be Rs. 3,000 i.e. 20% of Rs. 15,000. This deduction excludes any cess and surcharge.

Note: If there is no taxable income in the financial year, you can submit form 15G to avoid TDS deduction. Senior citizens have to submit form 15H to avoid TDS.

Debt Mutual Funds:

In case of Debt Mutual Funds, there is no concept of TDS for Resident Indians. However, for NRIs, TDS is deducted at 30% (34.608% including cess and surcharge) if the funds are redeemed on or before the completion of three years from the date of investment and at 20% (23.072% including cess and surcharge) if they keep invested for more than three years.

• On Dividend Distribution

Fixed Deposits:

No dividends are distributed in case of FDs. However, as mentioned above, you earn interest on the principal amount which is taxable. The tax levied on the interest earned is 30.90% if the taxable income is up to Rs. 1 crore for the investors falling under higher tax brackets. (33.99% if the taxable income exceeds Rs. 1 crore).

Debt Mutual Funds:

Tax is levied at the rate of 28.33% (including cess and surcharge) on the dividends declared by the Debt Mutual Funds for the both the Resident Indians as well as NRIs.

Tax implications on FDs and Debt Mutual Funds

3. Capital Protection

Fixed Deposits:

Your principal and interest amount in the banks are insured by Deposit Insurance and Credit Guarantee Corporation (DICGC) up to a maximum of Rs. 1,00,000, in case of any defaults by the bank or bank being closed down.

Debt Mutual Funds:

There is no assurance of capital protection as Debt funds are linked to the market. So, if the market goes down, your fund may perform adversely resulting in the loss of capital.

4. Risk & Return

Fixed Deposits:

The risk associated with FD is low, so is the return. Fixed Deposits offer fixed rate of return which varies from bank to bank based on the investment tenure, investment amount, the age of the investor, etc.


Debt Mutual Funds:

There are certain risks associated with Debt Mutual Funds.

There is no assurance of any fixed returns; reason being Debt funds linked to the market. If the interest rate goes up, Debt funds may churn out losses. Redeeming your funds after three years from the date of investment may fetch you a higher return due to the indexation benefit, compared to an FD held for a similar tenure.

FDs vs Debt Mutual Funds table

Also read: Understanding Debt Funds & associated risks

Final Words

FDs and Debt funds come with their own advantages and disadvantages. At one end FDs are less riskier and does not promise higher returns. On the other hand, Debt funds have high risk associated with them, thereby fetching higher returns compared to FDs.

If you are a risk-averse individual and are looking to invest for a duration of less than three years, you can go with FDs. Do remember to keep a check of the penalty charges in case of premature withdrawal on FDs. On the other hand, Debt Mutual Funds may have an exit load if the amount is withdrawn within a specified time limit from the date of investment. In case, your investment horizon is more than three years and you are willing to take the risk to attain higher returns, you may opt for Debt Mutual Funds.

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