FD vs Mutual Fund: In India, traditional investment options such as fixed deposits (FDs) and Public Provident Fund (PPF) have long been trusted for their guaranteed returns. However, as people become more inclined towards making money through their investments, market experts have highlighted that small and regular investments can create considerable money, and why consider mutual funds over the conventional methods of investments, like FDs and PPF, taking into account factors like taxation and inflation.
Key questions answered in this article:
- Why consider mutual funds?
- How does tax affect my investment returns?
- Real Returns vs Gross Returns: How do they differ?
- How to plan a portfolio mix by investment horizon?
- What are the current market opportunities?
Why consider mutual funds?
In a conversation with Zee Business, Akhil Chaturvedi, Director & Chief Business Officer, Motilal Oswal AMC, and Rishikesh Palve, Director at Anand Rathi Wealth, detailed how investors can leverage mutual funds, both equity and debt, to achieve long-term financial goals while minimising tax inefficiencies.
“Mutual funds, across various asset classes, have shown consistent wealth creation over the past 20–30 years,” said Chaturvedi. “Whether you invest in plain equity, debt, or hybrid funds, the returns historically outperform traditional FDs, PPF, and EPF.”
Palve emphasised that past performance shows mutual funds effectively create wealth, but comparisons with FDs or PPF require careful consideration of taxes, inflation, and investment horizon.
How does tax affect my investment returns?
Experts explained that the type of taxation plays a critical role in post-tax returns.
- FDs (Fixed Deposits): Interest earned is taxed annually according to the investor’s income tax slab. This reduces post-tax returns, and there is no way to set off this tax against other income.
- Debt Mutual Funds: Tax is applied on capital gains only at the time of redemption, which allows gains to compound before taxation. This is more flexible than FD taxation. Returns are around 6–7 per cent.
- PPF: Tax-free returns of approximately 7–8 per cent make it a good option for the debt portion of a portfolio, though liquidity is limited.
- EPF: Offers around 8.5 per cent returns for the service class and is safe for long-term debt investment.
“So if you want to create wealth over the next 20 years, in my opinion, the first choice should be equity mutual funds, followed by EPF, then PPF, and lastly fixed deposits,” said Chaturvedi.
Real Returns vs Gross Returns: How do they differ?
Palve emphasised the impact of inflation:
“Even if your FD gives 6–6.5 per cent and debt mutual funds give 7 per cent, once you adjust for 5–6 per cent inflation in India, the real purchasing power can decrease drastically over time. For example, Rs 100 invested in an FD today may effectively be worth only Rs 40 in real terms after 20 years post-tax and inflation.”
Equity mutual funds, particularly via systematic investment plans (SIPs), can significantly enhance long-term wealth.
Example: Investing Rs 10,000 per month for 20 years in an equity mutual fund yielding 12 per cent gross could grow to approximately Rs 1 crore. After adjusting for tax and 5–6 per cent inflation, the real purchasing power would be around Rs 33 lakh.
Comparatively, the same SIP in an EPF (~8.5 per cent return) would grow to Rs 62 lakh gross and Rs 50 lakh post-tax & inflation.
A recurring FD (~6 per cent) would yield roughly Rs 55 lakh gross, dropping to Rs 40 lakh after taxes and inflation.
“Gross returns can be misleading,” said Palve. “The real return, adjusted for tax and inflation, determines actual wealth creation over the long term.”
Recommended portfolio mix by investment horizon
Experts recommend a mix of equity and debt based on investment horizon and liquidity needs:
Long-term horizon (15–25 years): 80 per cent in equity mutual funds, 20 per cent in debt instruments such as PPF or debt mutual funds.
Medium-term horizon (5–10 years): A balanced mix of equity and debt, adjusting equity exposure to reduce market volatility risk.
Short-term horizon (1–2 years): Primarily debt instruments to ensure stability and liquidity.
Chaturvedi added, “For debt allocation, mutual funds act as shock absorbers against market volatility. Unlike FDs, where interest is taxed annually, debt funds allow compounding, and taxes are applied only at redemption.”
Equity funds and long-term perspective
The discussion also shows that equity funds require a long-term perspective. Historical data show that after seven years, equity returns stabilise, reducing risk significantly. For a 15–20 year horizon, increasing equity exposure maximises compounding benefits.
Chaturvedi added that compounding works best with long-term equity investment: “If you stay invested in equity for over 7 years, historical data shows minimum returns of 7–11 per cent, reducing risk and maximising wealth creation.”
What are the current market opportunities?
Chaturvedi pointed out that in the current market, mid-cap and small-cap segments show attractive valuations after recent corrections, offering potential growth for long-term investors.
“If an investor’s horizon is over 10 years, selective exposure to mid and small-cap funds can enhance wealth creation without taking on excessive short-term risk,” he said.
Key takeaways for investors
- Long-term growth: Equity mutual funds outperform FDs and PPF over extended horizons.
- Tax efficiency: Debt mutual funds allow deferred taxation, enhancing compounding benefits.
- Inflation matters: Always adjust expected returns for inflation to understand real purchasing power.
- Diversification: Maintain a portfolio mix of equity and debt tailored to your horizon and liquidity needs.
- Patience is crucial: Long-term commitment reduces equity risk and maximises returns.
