Fixed deposits and mutual funds are both very powerful investment tools for those who are looking to grow their savings.
 

However, these instruments are as different as they get and cater to very different financial needs and investment strategies. Whether you are looking for guaranteed returns or are willing to take some risks for the chance of higher gains, knowing the pros and cons of both FDs and mutual funds and where each instrument fits can enable you to make informed decisions.

• Fixed deposits offer assured returns, while mutual funds carry market-linked risks.
• Mutual funds can generate higher returns but come with a higher risk exposure.
• FDs are ideal for risk-averse investors who want guaranteed returns.
• Taxation differs for FDs and mutual funds, which impacts overall returns.

An FD is a traditional investment tool offered by banks and financial institutions. It enables us to deposit a fixed sum of money for a predetermined period in exchange for guaranteed interest. The interest rate is fixed at the time of investment, which means that the returns remain the same regardless of market fluctuations. FDs are a low-risk investment because your principal is secure, and you are guaranteed a fixed, definite return at the term’s end.
 

In most cases, fixed deposits can range from a few months to several years. The interest is either paid out periodically or compounded and paid at maturity. The principal investment is also fully returned upon maturity, making FDs a favourite for risk-averse individuals who value stability over higher but uncertain returns.

Mutual funds, on the other hand, work very differently. They are a collective instrument where money from many investors is pooled together and managed by professional fund managers. The fund managers allocate the funds across different assets, including stocks, money market instruments, and bonds. The goal is to generate returns by investing in a diversified portfolio that suits the fund's objectives. These objectives can be diverse, ranging from aggressive growth to steady income.
 

Unlike FDs, mutual funds do not promise guaranteed returns. Their performance depends on market conditions and the assets in which the funds are invested. That is why mutual funds carry a higher risk compared to fixed deposits. However, they also have the potential for much higher returns in the long run.

When deciding between FDs and MFs, several factors should be taken into account. Each offers distinct benefits, but both have a different place in a well-balanced investment strategy. Here’s a closer look at these instruments.
 

Liquidity

Fixed deposits offer limited flexibility. Although they can be withdrawn before maturity, doing so typically attracts penalties or lower interest earnings. Mutual funds are quite open-ended. They provide higher liquidity, as you can redeem your mutual fund units at any time.

Returns

The most significant difference between fixed deposits and MFs is the return profile. Fixed deposits offer a fixed interest rate that remains unaffected by market conditions. Mutual funds, on the other hand, do not guarantee any returns. The performance of mutual funds is linked to the assets they invest in, which can rise or fall depending on market trends. This implies a potential for higher returns with mutual funds but it also adds to the uncertainty associated with them.
 

Risk profile

Fixed deposits are considered one of the safest investment options as they offer guaranteed returns. The principal amount remains secure, and the interest rate does not change. Mutual funds, in contrast, carry market risks. Depending on the type (whether it's debt, equity, or hybrid), the risk level varies. Equity-based funds have higher risk but also offer the chance for higher returns, and debt-based funds are relatively safer but typically yield lower returns.
 

Taxation

Taxation rules also differ significantly between FDs and mutual funds. In the case of fixed deposits, the interest earned is added to your income and taxed according to your income tax slab. If your interest income exceeds Rs. 40,000 in a financial year, the bank will subtract TDS unless you submit forms like 15G or 15H.
 

For mutual funds, taxation is subject to its type and the holding period. Debt mutual funds attract an LTCG tax of 12.5% (without indexation benefits) if held for more than 2 years, whereas gains from shorter holdings are taxed according to your income slab. Equity MFs, on the other hand, if held for more than 12 months attract LTCG tax (12.5%) on returns higher than Rs. 1.25 lakhs. Short-term holding attracts a 20% tax if units are sold within a year.

Both FDs and mutual funds serve different investment purposes. While FDs offer stability and assured returns, mutual funds offer a potential for higher growth with greater risk. The right choice depends on your financial goals and risk tolerance, so pick wisely.