A Comparative Difference Between Debt Funds and Fixed Deposits

byPriyanka JuyalLast Updated: January 30, 2023
Debt Funds vs FD
Debt Funds vs FD

Debt funds and fixed deposits (FDs) are two popular investment choices that differ in terms of features, benefits, risk factors, and other factors. It is important to understand the differences between them before deciding which one to invest in.

Fixed deposits are often considered the safest investment option because they offer a fixed rate of interest and are insured by the government. Debt funds, on the other hand, are considered riskier because they are subject to market forces and conditions. Despite their differences, both debt funds and FDs are often chosen by investors to save for the future and grow their savings.

In this blog, we will explore the differences between debt funds and fixed deposits, so that you can make an informed decision about which one is right for you.

Comparative Difference Between Debt Funds vs FD

Particulars Fixed Deposits Debt Funds
Rate of returns 5% – 8% 7% – 9%
Risk Low Low to moderate
Liquidity Low

*High with Paytm Payments Bank
Withdrawal The 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 expenditure No management charges Nominal expense ratio is charged
Investment options Lump-sum investment
  • SIP investment
  • One time investment

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 Types of Debt Funds?

Listed below are the types of debt funds available:

Type of debt funds Explanation
Liquid funds
  • Invests in money market instruments
  • Maturity period of up to 91 days
  • Provides higher returns than savings account
  • Alternative to short-term investments
Dynamic bond fund
  • Invests in debt instruments with varying maturities that are further determined by the interest rate regime.
  • Considerable for investors with a moderate risk tolerance
  • Investment horizon is 3 to 5 years
Corporate bond fund
  • Invests 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 fund
  • Invests in money market instruments with a maximum of 1-year maturity
  • Great for investors with low risk debt securities for short term
Credit risk fund
  • Invests 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 fund
  • Invest a minimum of 65% of its investible corpus in floating rate instruments
  • Carries low-interest rate risk
Ultra-short duration fund
  • Invests in money market instruments and debt securities
  • Duration- 3 to 6 months
Low duration fund
  • Invests in money market instruments and debt securities
  • Duration remains between 6 to 12 months
Short duration fund
  • Invests in money market instruments and debt securities
  • Duration- 1 to 3 years
Medium duration fund
  • Invests in money market instruments and debt securities
  • Duration- 3 to 4 years
Medium to long-duration fund
  • Invests in money market instruments and debt securities
  • Duration- 4 to 7 years
Long duration fund
  • Invests in money market instruments and debt securities
  • Duration- more than 7 years
Gilt funds
  • Invests only in government securities, often high rated securities with very low credit risk
  • Ideal for risk-averse fixed-income investors
Credit opportunities funds
  • Relatively 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 plans
  • Known as closed-ended debt funds
  • Invests in fixed-income securities such as corporate and government bonds
  • Higher returns are not guaranteed

What are the Benefits of Debt Funds?

The following are the advantages of debt funds that make them 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 make 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

Things to Consider While Investing in Debt Funds

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

  1. Investors should be aware of and evaluate the risks associated with debt funds
  2. As debt funds do not guarantee returns, hence, investors should figure out if he/she would like to continue with debt funds or not
  3. Investors must decide which type of debt funds will best meet their financial objectives
  4. 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.
  5. Debt fund managers charge a management fee to manage funds
  6. It is advised to check different sources of investing in debt funds and the services offered by them
  7. Connecting with an expert can help you understand the fundamentals of debt funds, investment resources, eligibility criteria, etc.,

Read More: Why Invest in Debt Funds

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 it is, the depositor must pay a penalty.

What are the Types of Fixed Deposits?

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

Type of fixed deposits Explanation
Cumulative Fixed Deposit
  1. Interest is only available at the time of maturity
  2. Users are not eligible for interval-based interest
  3. Higher interest rate
  4. Suitable for people who are not looking for regular interest payment
  5. FD tenure ranges from 1 year to 5-year
Non-Cumulative Fixed Deposit
  1. Interest provided at regular intervals
  2. FD tenure ranges from 1 to 5 years
  3. In case of regular interest payout, one will be eligible for a decreased amount at the time of maturity
  4. Suitable for people who need regular income in the form of interest
Bank deposits
  1. Offered by banks to customers with saving accounts
  2. Rate of interest is lower than the rates offered by non-banking financial companies
Company deposits
  1. Offered by NBFCs with a higher rate of interest
  2. For companies with good creditworthiness
Senior citizen FD
  1. For people above 60 years of age
  2. Offers higher rate of interest as compared to other FDs
  3. Flexible tenure
  1. Applicable for NRIs, OCI, PIO with NRO accounts
  2. Higher rate of interest as compared to traditional saving accounts
  3. Fixed tenure
  4. Payment mode- NEFT/RTGS from NRO bank account
Regular FDs
  1. Regular form of investment
  2. User can invest the amount for a particular time period
  3. A predetermined rate of interest is offered
  4. High interest rate
Tax saving FDs
  1. Offered by a major number of banks
  2. Tax exemption up to Rs. 1.5 lakh annually
  3. Lock in period of 5 years, before that, the amount cannot be withdrawn
  4. One-time lump sum amount deposit
Standard FDs
  1. Fixed tenure
  2. Predetermined rate of interest
  3. Tenure starts from 7 days to 10 years
  4. 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

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)

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?

Debt funds, also known as fixed-income funds, invest in fixed-income securities such as bonds and other debt instruments. These funds tend to be less risky than equity funds, which invest in stocks, but there is still some level of risk associated with them.

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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