In the money market sector, even today debt mutual funds and fixed deposits are the most debated investment products. Although both these investment avenues invest in debt instruments, they differ in features, benefits, and associated risks. If you are stuck thinking about whether you should be investing in debt funds or FDs, you need to understand all the different nuances of these investment avenues to make an informed investment decision.
While a fixed deposit is a traditional investment instrument that is deemed to be the safest investment scheme out there, debt mutual funds are considered to be relatively less risker than equity funds but riskier than fixed deposits.
While these two investment options will always remain debatable, we will discuss both debt funds and fixed deposits for investors to identify the right scheme for their financial goals.
What is a Debt Mutual Fund?
Mutual funds are a pool of assets that can be largely categorized under equity and debt. While equity funds predominantly invest in the stock market, debt mutual funds invest the majority of their investible corpus in fixed income securities. Some of the most common debt instruments in which debt funds invest are corporate bonds, government backed securities, debentures, commercial paper, certificates of deposit, CBLO, reverse repo, etc. These debt instruments in which the funds invest have a predefined maturity duration. Depending on the maturity duration, returns from debt funds may or may not be affected by fluctuations in interest rates. Any upheavals in the equity markets do not affect the performance of debt mutual funds. Debt funds do not have a lock-in period however, if you invest in a close ended scheme, you cannot redeem your units until it turns into an open ended scheme.
What is a Fixed Deposit?
Also referred to as ‘term deposits’ by a few, fixed deposits are investment schemes offered by Non-banking financial companies (NBFC) and banks. Deemed as the safest investment instrument, an individual can make a lump-sum investment and lock their money in for a fixed duration. Investors get an opportunity to earn interest on their investment sum for the duration they remain invested. The interest rate promised before your money is locked-in is offered upon the maturity period irrespective of the existing interest rate situation. Those who deposit their money in FD can earn periodic interest or choose to earn interest upon maturity. The lock-in periods of the fixed deposits may vary anywhere between 7 days to 10 years. However, the maturity period may vary from one bank to another.
Understanding the differences between FDs and Debt Mutual Funds
Fixed deposits have a lock-in period and if you decide to redeem your investments before the maturity period, you have to pay a fine. On the other hand, debt mutual funds do not have any lock-in. In fact, a lot of investors diversify their investment portfolio with debt funds so that they can bring in some liquidity. Schemes like liquid funds even have instant redemption facilities wherein the money is transferred to their savings account within 24 hours after redemption of units. Also, investors can withdraw some of their units or they can choose to withdraw their entire investment. Debt funds offer flexibility and also the SIP feature where one can invest a fixed sum monthly. Investors need not have a large capital to start their investment journey with debt funds.
However, returns from debt funds are not guaranteed and are subject to how the underlying securities of the portfolio react to interest rate fluctuations and credit risk. Hence, investors should understand their goals, their investment objective, and their risk appetite before deciding where to invest their hard earned money in.