A Comparative Difference Between Debt Funds and Fixed Deposits

Debt Funds vs FD

Debt fund vs FD or Fixed deposits are the most debatable investment choices. Both of them differ in terms of features, benefits, risk factors, and other factors. As a result, it is critical to understand the differences between them before investing in either one or both of them.

Fixed deposits are often considered the safest investment option whereas debt funds are riskier due to their reliance on market forces and conditions. Even though debt funds vs FD are debatable investment options, they are often chosen by investors to save for their future and grow their savings.

In this blog, we will learn the difference between a debt fund and a fixed deposit in order to begin investing for the future.

What is a Debt Fund?

Debt funds are mutual funds that invest in fixed income instruments such as corporate bonds, treasury bills, government bonds, certificates of deposit, commercial paper, and others. The following points provide more information about debt funds:

  • The debt fund based income instruments have a pre-decided maturity date
  • The returns on debt funds are unaffected by market fluctuations
  • Debt securities are considered one of the options with low risk
  • Investing in debt funds provides investors with consistent interest income as well as capital appreciation
  • The interest rate to be received after maturity is predetermined by the issuer of debt instruments
  • Debt funds are also known as fixed-income securities

What are the Benefits of Debt Funds?

The following are the advantages of debt funds that make it a suitable investment option based on risk factors and tolerance:

  • Debt funds can provide capital appreciation over time; however, the returns on debt funds are not guaranteed and are frequently driven by market forces; however, they carry a lower level of risk than equity funds
  • Tax reduction made debt funds the most suitable options considered by investors
  • There is no lock-in period with debt funds. Some debt funds, however, have an exit load
  • Debt mutual funds are liquid in nature, so investors can easily withdraw funds from them
  • Investing in debt funds allows investors to diversify their portfolios
  • Debt funds allow you to transfer money between funds
  • Investors have the option of investing a lump sum in debt funds and transferring a portion of their investment

Who Should Invest in Debt Funds?

  • Debt funds are appropriate for people with short- and medium-term investment goals
  • Such funds are an option for investors who have a low risk tolerance
  • A person with surplus funds can invest in debt funds
  • Debt funds are an option for investors looking to diversify their portfolio

What are the Types of Debt Funds?

Listed below are the types of debt funds available-

Type of debt fundsExplanation
Liquid fundsInvests in money market instruments
Maturity period of up to 91 days
Provides higher returns than savings account
Alternative to short term investments
Dynamic bond fundInvests in debt instruments of different maturity that are further based on interest rate regime
Considerable for investors with a moderate risk tolerance
Investment horizon is 3 to 5 years
Corporate bond fundInvests up to 80% of its total assets in corporate bonds with the highest ratings
Excellent choice for investors with low risk tolerance
Prefered by those who seek to invest in high-quality corporate bonds
Money market fundInvests in money market instruments with a maximum of 1-year maturity
Great for investors with low risk debt securities for short term
Credit risk fundInvests up to 65% of its investible corpus in corporate bonds with ratings lower than the highest quality corporate bonds
Carries minor risk
Provides higher returns than the highest-quality bonds
Floater fundInvest a minimum of 65% of its investible corpus in floating rate instruments
Carries low-interest rate risk
Ultra-short duration fundInvests in money market instruments and debt securities
Duration- 3 to 6 months
Low duration fundInvests in money market instruments and debt securities
Duration remains between 6 to 12 months
Short duration fundInvests in money market instruments and debt securities
Duration- 1 to 3 years
Medium duration fundInvests in money market instruments and debt securities
Duration- 3 to 4 years
Medium to long-duration fundInvests in money market instruments and debt securities
Duration- 4 to 7 years
Long duration fundInvests in money market instruments and debt securities
Duration- more than 7 years
Gilt fundsInvests only in government securities, often high rated securities with very low credit risk
Ideal for risk-averse fixed-income investors
Credit opportunities fundsRelatively newer to other types of debt funds
Do not invest as per the maturities of debt instruments
Earns higher returns by investing in lower-rated bonds or taking a credit risk
They are considered riskier debt funds
Fixed maturity plansKnown as closed-ended debt funds
Invests in fixed-income securities such as corporate and government bonds
Higher returns are not guaranteed

Things to Consider While Investing in Debt Funds

Following are the number of points to consider while investing in debt funds-

  • Investors should be aware of and evaluate the risks associated with debt funds
  • As debt funds do not guarantee returns, hence, investors should figure out if he/she would like to continue with debt funds or not
  • Investors must decide which type of debt funds will best meet their financial objectives
  • Debt funds can be considered another source of income to supplement regular salary income; therefore, investors must decide whether they want another source of income with risk factors or not.
  • Debt fund managers charge a management fee to manage funds
  • It is advised to check different sources of investing in debt funds and the services offered by them
  • Connecting with an expert can help you understand the fundamentals of debt funds, investment resources, eligibility criteria, etc.,

What is a Fixed Deposit?

Fixed deposits are also referred to as “term deposits” or “time deposits.” It is a type of investment instrument that is provided by non-banking financial companies (NBFCs) and banks. It is regarded as the safest investment option among many others, and users can deposit a lump sum amount for a specific time period. In addition, FD provides users with a plethora of other features such as-

  • Depositors can earn interest on their deposits for a set period of time
  • Once locked in, the interest rate is unaffected by changes in the market or interest rates
  • Depositors can earn interest either on a regular basis or at the maturity of their FD
  • FD tenure can range from 7 days to 10 years or more (might vary from one bank to another)
  • A fixed deposit amount cannot be withdrawn before the maturity date, and if a depositor wishes to do so, he or she must pay a penalty

Who Should Invest in Fixed Deposit?

People who can/should invest in fixed deposits are listed below

  • Someone who is not willing to take market risks
  • Individuals with taxable income can use FDs as a tax-saving investment vehicle.
  • A person who wishes to have a regular source of income during their post-retirement years.
  • Anyone who is a housekeeper and has decent money to invest

What should be taken care of when Investing in Fixed Deposits?

The right way to choose fixed deposits is to go through the following factors-

  • Compare the various types of fixed deposits provided by various banks
  • The type of fixed deposit that best meets your needs
  • The lender’s credibility as determined by the ICRA and CRISIL ratings
  • The selected bank’s customer service
  • If there is FD related flexibility given by the bank
  • If a large number of documents must be submitted, or if only KYC documentation is required (like in the case of Paytm Payments Bank fixed deposit process)

What are the Types of Fixed Deposits?

Here is a comparison chart of different types of fixed deposit-

Type of fixed depositsExplanation
Cumulative Fixed DepositInterest is only available at the time of maturity
Users are not eligible for interval-based interest
Higher interest rate
Suitable for people who are not looking for regular interest payment
FD tenure ranges from 1 year to 5 year
Non-Cumulative Fixed DepositInterest provided at regular intervals
FD tenure ranges from 1 to 5 years
In case of regular interest payout, one will be eligible for a decreased amount at the time of maturity
Suitable for people who need regular income in the form of interest
Bank depositsOffered by banks to customers with saving accounts
Rate of interest is lower than the rates offered by non-banking financial companies
Company depositsOffered by NBFCs with a higher rate of interest
For companies with good creditworthiness
Senior citizen FDFor people above 60 years of age
Offers higher rate of interest as compared to other FDs
Flexible tenure
NRIs FDsApplicable for NRIs, OCI, PIO with NRO accounts
Higher rate of interest as compared to traditional saving accounts
Fixed tenure
Payment mode- NEFT/RTGS from NRO bank account
Regular FDsRegular form of investment
User can invest the amount for a particular time period
A predetermined rate of interest is offered
High interest rate
Tax saving FDsOffered by a major number of banks
Tax exemption up to Rs. 1.5 lakh annually
Lock in period of 5 years, before that, the amount cannot be withdrawn
One time lump sum amount deposit
Standard FDsFixed tenure
Predetermined rate of interest
Tenure starts from 7 days to 10 years
Higher interest rates as compared to saving account

What are the Benefits of Fixed Deposit?

The benefits of fixed deposits are numerous, following are a few among them-

  • Fixed deposits are considered the safest investment option as compared to other saving investments options
  • Customers can use the FD calculator on the respective bank’s website to calculate the interest they will receive on their deposits
  • Upon the maturity of a fixed deposit account, customers can either direct banks to credit the amount or reinvest the amount for another pre-decided tenure
  • The interest rate on the fixed deposit account remains unchanged even after market fluctuations, that too, throughout the decided tenure
  • FDs offers an assured rate of interest
  • Customers can reinvest the matured FD amount again for the decided tenure, on which, compound interest will be provided to him/her
  • Banks allow their customers to choose the duration of their fixed deposits
  • There are several banks that offer tenure from 7 days to 10 years
  • Several banks offer fixed deposits with tax advantages

Comparative difference between Debt Funds vs FD

ParticularsFixed DepositsDebt Funds
Rate of returns5%-8%7%-9%
RiskLowLow to moderate
LiquidityLowHigh
WithdrawalThe depositor must pay a penalty for early withdrawal.Premature withdrawal is permitted with or without an exit load (depends on the type of mutual fund)
Investment expenditureNo management chargesNominal expense ratio is charged
Investment optionsLump-sum investmentSIP investment
One time investment
FAQs
Is it possible to withdraw the FD amount before it matures?
Banks offer ease for premature withdrawal of the amount from FD with a penalty to be paid.
What is the level of risk associated with debt funds?
The risk factor for debt funds ranges from low to moderate.
Who should invest in debt funds?
Investors who want to achieve their short- or medium-term financial objectives should consider investing in debt funds. Apart from that, people looking to diversify their portfolios and those with excess funds can invest in debt funds.
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