Fixed Deposits vs Debt Mutual Funds, where should you invest for the short term?

Fixed Deposits vs Debt Mutual Funds, where should you invest for the short term? | Vrid
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When it comes to investing for the short term, there are multiple options available. Two well-known investment avenues are debt mutual funds and fixed deposits.

Both investment options have advantages and disadvantages, and choosing between them can be a tough decision.

Let’s take a closer look at debt mutual funds and fixed deposits after the Finance Bill 2023 amendments. And compare them to help you make an informed decision.

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Investing is an essential component of personal finance, and it is crucial to choose the right investment option that meets your financial goals. 

Short-term investment options are ideal when you want to invest money for less than 3 years. This can be for any short-term goals, emergency fund, etc.  

Until now, two clear short-term investment options were debt mutual funds and fixed deposits. But after the recent amendments introduced by the Government in Finance Bill 2023, things have changed for debt mutual funds. 

The Government removed the indexation benefits received by debt mutual funds, and now, it is taxed on par with fixed deposits. We have discussed this in detail here.

After the announcement of the amendments, the market was filled with a loud echo declaring debt mutual funds are dead.

But is that really the case? Of course, the tax benefit was the main selling point of debt mutual funds. But that wasn’t the only factory that made debt mutual funds attractive compared to fixed deposits. 

Let’s discuss the other factors. 

Factors of debt mutual funds making it still a better investment than fixed deposits:

1. Mode of investment

You can invest a lump sum amount or a small amount monthly while investing in debt mutual funds. But in fixed deposits, you can only invest in lump sum. A monthly investment option is not available. 

Recurring Deposit (RD) does provide the option to invest monthly, but then the returns are low compared to fixed deposits. 

2. Returns

Currently, fixed deposits offer a return of about 7-9%. Sometimes, they offer better rates than debt mutual funds, but this is not always true. Interest offered on fixed deposits keeps changing, and maybe next year’s returns would be around 6-7%.

Whereas in debt mutual funds, the interest returns are between 7-9%, and there are chances of gaining a capital gain. So, on average, the returns offered by debt mutual funds are higher than those offered by fixed deposits. 

3. Liquidity

Debt mutual funds are more liquid than fixed deposits. You can redeem your investment in debt mutual funds, and the funds will be credited to your bank account within a few days. 

In contrast, fixed deposits have a lock-in period, and you cannot withdraw your funds before the end of the tenure without incurring a penalty of 0.5 to 1%.

4. Risk

Debt mutual funds are subject to market risks, and the returns can vary based on market conditions. However, since these funds invest in a diversified portfolio of fixed-income instruments, the risk is relatively low.

Fixed deposits, on the other hand, are almost no-risk investments and are not subject to market risks. Your money in fixed deposits along with your savings account is insured up to ₹5 lakhs per bank.

5. Taxation

Though the tax benefit of indexation is removed from debt mutual funds. There is still a tax benefit in investing in debt mutual funds. 

You know that investment in fixed deposits is taxed on your slab rates. But the problem is even when you invest in a 3-year FD, you are taxed every year on the interest earned. And if your interest income is beyond 40,000, the bank would deduct a 10% TDS. Learn more about this here.

But in debt mutual funds, you pay tax only when you sell your investments. If you sell your debt mutual funds units after 3 years, you pay tax in the 3rd year. Until then, the compounding works for you.

Where should you invest for the short term?

The choice between fixed deposits and debt mutual funds depends on your financial goals, risk appetite, and investment horizon. 

Though the above factors make investing in debt mutual funds more appealing. Most people feel uncomfortable investing in debt funds because of a lack of knowledge, varying returns, etc. 

If you don’t have enough time to learn more about investing in debt mutual funds and want to keep it simple, then surely you can invest in fixed deposits. 

Also, banks have started offering more useful features with fixed deposits, like auto-sweep and flexi-fixed deposits.

And, if you want to learn more about debt mutual funds, you can start from here.

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Still Curious?

If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.

Dezerv – Mutual Funds will never be the same

BQ Prime – Debt MFs Lose Tax Advantage: Repercussions And Best Way Forward

Cleartax – Why Debt Mutual Funds are Better than Fixed Deposits

Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.


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DISCLAIMER: This newsletter is strictly educational and is not an investment advice or a proposal to buy or sell any assets. Please be careful and do your own research.

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