Debt Mutual Funds Vs Fixed Deposits: Where Should I Invest?

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oi-Vipul Das

| Updated: Thursday, May 27, 2021, 14:25 [IST]

You may have discovered that some debt mutual funds have produced modestly negative returns in recent months. The magnitude of negative returns will vary depending on the type of funds in which you invest. On the other hand, certain banks and non-banking financial companies have begun to raise deposit rates, particularly for long-term FDs. Fixed deposit interest rates are pre-determined by banks and are dependent on the term specified. Whereas the overall interest rate change has a big impact on debt fund performance. One advantage of fixed deposits is that market moods do not influence the returns you get. Consequently, during periods of low-interest rates in the economy, debt funds often outperform fixed deposits by a significant percentage. So to make a good investment bet, let’s look at the differences between debt mutual funds and fixed deposits in this article.

A glance at fixed deposits and debt mutual funds

You invest a lump-sum amount of money in a fixed deposit (FD) account for a fixed tenure at a fixed rate of interest which is not impacted by any market fluctuations. Though investing in fixed deposits for a tenure of 5 years will allow you to seek tax benefits, they are the most preferred investment options for senior citizens as they get additional interest rate than the general public in the form of regular income. In terms of risk, debt funds are riskier than traditional FDs. The basic purpose of a debt fund is to provide a consistent return to investors throughout the course of the investment period. Debt funds are safer than equity funds because the underlying assets in debt funds are generally bonds, government securities, money market instruments, commercial papers, and other debt-related securities. However, MFs in the debt category offer a greater range of options for maintaining short-term investments and can be utilised as a substitute to bank FDs.


When it comes to determining which investment option to pursue, risk is likely the most significant aspect to discuss. FDs provide investors with guaranteed returns, and the specified interest you get does not fluctuate from the ups and downs of the market. If you want guaranteed returns with no risk, bank fixed deposits are a good option. If you want to reap possibly better returns at the sacrifice of a higher risk, you may explore investing in funds from appropriate mutual fund categories that match your goals and risk tolerance. When comparing debt funds versus FDs in terms of risk, the bank ensures capital safety because your deposits are insured by the DICGC. If a lender goes bankrupt, investors’ deposits – including principal and interest – are insured up to Rs 5 lakhs by DICGC, and hence FDs are considered risk-free investments. Debt funds are vulnerable to market fluctuations, and capital security is not guaranteed. In a debt fund, there are two types of risk: interest rate risk and credit risk. Interest rate risk is lower in debt funds that invest largely in money market instruments, but interest rate risk is higher in Gilt funds with long durations. The credit risk is determined by the underlying securities’ credit ratings. The interest rate on a fixed deposit is pre-determined for the duration of the deposit. Whereas, returns on a debt fund may fluctuate based on interest rate movements. If interest rates rise, the yields on your portfolio’s securities drop, resulting in lower net asset values (NAVs) and, as a result, lower returns. If interest rates decrease, on the other side, NAVs will rise.


Fixed deposits and debt funds provide different returns, just as they do in terms of risk. The rates of return on FDs vary depending on the term of the deposit, the type of depositor you are, and the current market rates. When market rates are low, FD interest rates typically fall as well, and vice versa. The repo rate is an important factor in determining the market rate. Nevertheless, once locked in, your investment will continue to earn the same interest at a fixed rate for the duration of the term, regardless of whether market rates rise or fall. Debt funds, unlike FDs, do not promise guaranteed returns. Debt fund returns are market-linked, but they have historically outperformed FDs having similar maturities, according to past records. When general interest rates rise, appetite for current debt funds falls, resulting in a decrease in NAV and yields. When interest rates fall, the reverse happens.


The interest you receive from a fixed deposit is added to your net income and taxed according to your tax slab rate. TDS is levied on interest earned if it exceeds Rs. 40000 for regular residents and Rs. 50000 for senior citizens in a year. Whereas there are short-term capital gains (STCG) for holding durations of up to 36 months and long-term capital gains (LTCG) for holding durations of more than three years when it comes to debt mutual funds. If you withdraw debt funds before three years, they will be treated the same as a fixed deposit – gains will be added to your income, and you will be subject to income tax as per your slab rate. Debt funds are taxed at 20% with indexation and 10% without indexation if held for more than three years.


Because debt funds can be redeemed at any time, they are more liquid than fixed deposits. You can make premature withdrawals, but after incurring a penalty, you may be able to earn a lower interest rate on the amount withdrawn from your fixed deposit. You can redeem your debt fund assets at the current NAV, which may be lower or higher than the amount you initially deposited. Exit load is applied on debt fund redemptions during the exit load period and is levied on the redemption amount. You can redeem units for free after the exit load time has ended. Before investing, you should look at the exit load structure of debt funds and the penalty charges imposed by banks on fixed deposits.

Tenure and flexibility

There isn’t a lot of diversity when it pertains to fixed deposits. Fixed deposits are available at the post office or banks. Banks provide different interest rates which are currently around 5.5% of some leading banks. Compared to commercial banks, some small finance banks may give you higher interest rates of more than 7%, but they also involve risk. Debt MFs invest in government bonds, PSUs, money market, corporate debentures, and so on. Each category of the fund has its own set of risks and perks. Fixed deposits are for a specific period, ranging from a week to ten years. Debt funds are offered for a variety of time periods, ranging from one day (overnight funds) to more than seven years (long duration funds). There are also short-term debt funds that invest in bonds with a one- to three-year maturity duration. It’s a good fit for low-risk investors who have a similar holding period. For investors with higher tax brackets, it is a more tax-efficient option than fixed deposits. As a result, you must make your decision based on your financial objectives and investment term.

Our take

Debt funds have historically provided superior returns than fixed deposits. Debt funds may be a good bet from a tax standpoint, especially if you plan to maintain them for a long period. If capital security and guaranteed returns are your top priorities, a fixed-deposit investment is a way to go. When comparing Debt Fund vs FD, you may earn possibly higher returns by investing a portion of your fixed-income assets in debt mutual funds. You can also enjoy tax benefits in debt mutual funds, which is the main advantage of debt mutual funds. However, if you are in a higher tax rate and have a longer investment horizon than three years, debt funds are more tax-efficient than bank FDs. But here the matter of concern is that due to interest rate volatility, debt funds may have negative returns and Long-term debt funds are more exposed to interest rate risk. Debt funds, on the other hand, invest in fixed-income assets which makes them less risky than equity funds. Based on your investment goals and risk profile, you may choose the best debt fund. Take a peek at the debt fund’s portfolio. Debt funds with AAA-rated bonds in the portfolio are secure to bet.

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