Investment strategies develop and transform as per our changing circumstances. A seasoned, successful investor of today would have started out with small, careful steps at the outset of his investment journey. Take your own entry into investing. When you first began wondering how you could put your savings to good use. Surely, as eager as you were for those funds to grow, like for all early investors, the need for safety was also a primary concern. Choosing Fixed Deposits would have been natural then. An established familiar mode of investment, any senior family/mentor that you turned to would have also likely endorsed this as safe, reliable and convenient. But today, this default sweeping of excess saving balances into FD's may no longer be as satisfying as it felt at the outset.
A deeper look into FDs.
One of the biggest downfalls of choosing fixed deposits comes from its low returns. Though FDs are advertised to deliver 7-8% in some cases, this rarely results in returns that are higher than the inflation rate i.e., Nominal Real Returns
For instance, as of Feb '23 the CPI Inflation was about 6.5%, while the SBI FD interest rate for a 1 Yr maturity was about 6.8%. This results in a real return (Inflation adjusted) of 0.3%. And If we were to look back to the past 50 years, the median average Real returns of Fixed Deposits have delivered approximately 0.78%. Here’s a quick snippet below.
So with growing disposable income, have you been wondering whether it is time to change to a different mode of investment that provides higher returns?
More lucrative opportunities offered by the stock market are tempting at this stage. But we all know that prudent, successful equity investment requires a great deal of expertise, research and overseeing. While the gains can be exponential, the nagging worry of devastating losses is also troubling. Your existing commitments may not leave you the time and energy to meet such a demanding responsibility. So any delay or hesitation on your part is understandable. Caution with your hard-earned funds is indeed necessary.
Would it be better for you to stay with FDs after all? Or is there a way to avail of greater returns opportunities, without taking on undue risk?
Debt Mutual Funds offer a suitable middle path. Here are some advantages that they hold over FDs
Risk: Though perceived as zero risk investments, we should remember that in the case of a bank failure (seen far more often than one would like), under the current bank deposit insurance scheme, only deposits up to ₹1 lakh are insured and paid back to the depositor. Mutual Funds which are generally seen as uniformly much riskier are actually of different types and carry varying levels of risk. Hence, the safety difference between FDs and Mutuals may not be as great as one has imagined so far. Careful consideration can help you pick Mutual Funds that are suitable to your risk comfort.
Post-Tax Rate of Returns: Bank FDs currently fetch a return of between 6–6.5% while Mutual Funds range between 10–15%. Whereas the lower risk associated with FDs makes this seem like a decent compromise, that conclusion changes when we compare post-tax returns: interest on FDs is taxable, whereas the dividends on MFs are tax-free up to Rs.10 lacs. Further, in the case of MF long-term gains, you would enjoy the benefit of indexation. What this effectively means is that instead of a possible post-tax return of 4% from FDs, you could be earning as much as 8% p.a. or even more Potentially half of the returns you could have had — at a comparable risk level — are sacrificed by opting for FDs.
The implication of Tenure: As we saw above, annual post-tax returns tend to be more favourable in the case of Mutual Funds. But when we add in the dimension of time, this impact can become even more significant. FDs will continue to give a constant rate of return, year after year, regardless of changing inflation or markets. Whereas Mutual funds offer better returns on long-term investments as they are market-linked. If you were to choose the Growth option, automatic and continual re-investment of your (higher) earnings further enhances the difference at the end of a longer term. So the younger the age at which you switch from FDs to MFs, the greater the advantage in the longer run Longer the tenure of investment, the better the returns from Mutual Funds.
Cost and Ease off Liquidating: Most banks will charge a penalty for premature withdrawal and a lowered interest rate is applied from the time of inception. This can prove rather expensive, especially in longer tenure deposits. Also, in many cases, you have to deal with vexing and time-consuming formalities. You may have to visit the bank in person, collect signatures from all FD joint holders and address the relationship manager’s duty-bound attempts to dissuade you from withdrawing the funds In contrast, Mutual Funds can be exited quickly and conveniently, with zero or negligible exit load.
Ease of Operation: In the case of FDs, additional investments require you to go through all the formalities again and generate a fresh Deposit. Then, you will have the tiresome task of monitoring the varying amounts, tenures, rates of interest, nominations and certificate numbers carefully. Some of the banks do not automatically credit closure proceeds to your account and failure to follow up in time may mean your funds are left lying idle without earning interest in the interim On the other hand, Mutual Funds — with an ease comparable to that of a savings account — make it simple, quick and convenient to add, withdraw or even switch funds under a single folio.
By choosing a suitable MF, you can find the bridge to higher returns offered by diverse debt and equity instruments, while still staying at risks comparable to FDs.
But before you take this logical next step in your investing journey, a note of caution: Do evaluate the numerous Mutual Funds carefully before investing. Knowledge of the fund’s past performance, the fund manager’s record, their portfolio mix and other details should be matched to your personal needs.
The expertise of a Financial Advisor who understands your requirements and investing goals can help you identify the Mutual Funds which are a correct fit for you.