Where should you invest in Bank FDs or Debt Mutual Funds?

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As the global economy has entered a phase where the interest rates have been shooting up abruptly, debt investments have begun to pose as an attractive option for investors. While debt mutual funds provide many similar benefits as compared to bank FDs, it has caused investors to feel mixed up about selecting the suitable investment option for their portfolio.

Where should you invest in Bank FDs or Debt Mutual Funds?

To understand how to choose between a bank fixed deposit and a debt mutual fund, let us analyze the key differences and compare the pros and cons of these two investment avenues.

Tax efficiency

Talking about bank fixed deposits, when investors invest their money into a bank FD, whatever interest is being generated will be taxable to the investors as per their tax slabs. So, if a person falls under the 20% tax slab, they will have to pay 20% tax on the interest earned. Similarly, if the person is in a 30% tax slab rate, then the person will have to pay 30% tax on the interest income. Here the duration has no relevance. So, whether you are investing for a year or two years, five years, or even more, you will be liable to pay taxes as per your slab rate upon the interest that is being earned.

On the other hand, for debt mutual funds, the taxation policy is quite different. Here the duration has a purpose. You have to decide whether you want to invest for the short term or a long term. If you are redeeming your investment within three years, it is considered short-term. And the taxation for the short-term is similar to bank FDs, which means, here, you will be taxed as per your slab rate. But in case you stay invested in a debt mutual fund for a long period of time, i.e., more than 36 months or more than three years, the taxation will be 20% with an indexation benefit.

Indexation benefit allows you to reduce your tax liability by including inflation while calculating your taxable amount. So, whenever you’re finding out the gain amount, it’s not just the absolute gain, but it will be the inflation-adjusted gain over which you will have to pay 20% taxation.

Let us understand this difference with the help of an example. An investor invests ₹1,00,000 into a debt mutual fund for a period of four years. Assuming this fund is giving a return of 8% CAGR. In that case, after four years, this investment value will become somewhere around ₹1,36,000. So, once this investor sells this investment or redeems this investment after four years, ₹36,000 will be the absolute gain. But by applying indexation, you will not have to pay taxation on the entire 36,000. You will have to calculate the indexed value of the profit that you have earned and pay a 20% tax on that amount. As per our example, the taxable amount will be somewhere around ₹3566 after considering the indexation benefit.

However, if you invest the same ₹1,00,000 in a bank fixed deposit, earning an interest rate of, let’s say, 8% only, the taxation will come to around 10,800 considering a person is in a higher tax slab rate, which is 30%. If you’re investing for a shorter period of time, that is, up to three years, then there is no difference in taxation between bank FDs or debt mutual funds. But yes, if you are investing for the long term, debt mutual funds will be more tax efficient because of the additional benefit of indexation.

Rate of return

The second difference between the two is based on the return. When discussing bank fixed deposits, the returns are fixed and guaranteed for a specified tenure. Whereas, if you’re investing in debt mutual funds, the returns are not guaranteed as it is market linked and depends on how the interest rate movements take place in the market.

Moreover, if we see the range of interest rates, in bank fixed deposits, your interest rates could be in the range of 5 to 7%. If you’re going for a corporate FD, your returns could be higher. On the other hand, if you talk about debt mutual funds, if we check the past returns of medium-duration funds or long-duration funds, the returns are between 6 to 9%.

Investment methods

Debt mutual funds give you the option to invest either in lump sum or SIPs. You can invest in fixed, regular installments with an amount as low as ₹500. This makes it convenient for investors who do not have a large corpus. However, for bank FDs, you can only opt for lump sum investments, which makes having a large fund important in order to invest in a bank FD account.

The risk factor

Both investments are low risk because both fall into the debt investment space. But if we compare the two, bank fixed deposits have a lower risk because these are guaranteed and generate fixed returns for you. On the other hand, because debt mutual funds are invested in bond markets and are market-linked, comparatively, they carry a little higher risk.

Debt mutual funds are subject to interest rate risk, liquidity risk, inflation risk, and default risk. One of the major advantages of bank fixed deposit is that RBI insures your principal and the interest amount in FDs in a bank up to a limit of 5 lakhs, while debt mutual funds have no such benefit.

A summary of the differences between a debt mutual fund and a bank FD

Debt mutual funds

  • Low to moderate risk that includes inflation risk, credit risk, etc.
  • High liquidity 
  • Linked with the market
  • Does not guarantee the security of your principal amount 
  • Can choose between a lump sum or SIP investment
  • Higher returns

Fixed Deposit

  • Negligible risk 
  • Low liquidity 
  • Not associated with the market 
  • Pays back the principal amount along with interest at maturity 
  • Pays a fixed rate of compound interest only at the end of the term
  • Can only opt for lump sum investment 
  • Lower returns


Now coming to the most important question, where should you invest your money? Well, here, the answer will depend upon your risk appetite. Both these investments are suitable for low to moderate-risk profiles. But in case you’re investing in a bank fixed deposit, it is suggested that you park your money for your short-term requirements. Here you can park your money for two or three years for emergency needs, especially if you are in the lower tax bracket.

But investors in a higher tax bracket who are also looking out for certain conservative investments for a longer period can opt for debt mutual funds. Under debt mutual funds, there are a lot of categories based on different time horizons, such as short-term, medium-term, and long-term. So, considering your investment horizon and which goal you are mapping this investment to, select a dead mutual fund category accordingly.

Disclaimer: The views expressed in the blog are purely based on our research and personal opinion. Although we do not condone misinformation, we do not intend to be regarded as a source of advice or guarantee. Kindly consult an expert before making any decision based on the insights we have provided.

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