KNOWLEDGE CENTRE Mutual Funds Investment Guide / Liquid Mutual Fund vs Fixed Deposit—Which Is Better?
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Liquid Mutual Fund vs Fixed Deposit—Which Is Better?


Liquid fund vs Fixed Deposit – which is better?

Fixed deposits (FDs) have been a favorite investment option for many. Considering a no-risk factor and a guaranteed return, individuals prefer fixed deposits for the short term. Since interest rates on fixed deposits have been on a gradual decline over the past few years, individuals are looking for options where they may park their money and maximize wealth.

That’s when mutual funds are considered. Liquid funds, a popular category of mutual funds, offer much higher returns than that of fixed deposits. Mutual funds are managed by fund managers who make it a point to diversify the portfolio and reduce the risk. They invest in debt and equity and choose funds that are consistently well-performing.

Liquid funds vs Fixed Deposit (FD)

A detailed comparison of both the investment options will allow investors to make the right choice. Here are a few factors that may affect your decision:

  1. Risk
  2. Availability of funds
  3. Returns
  4. Liquidity
  5. Tax treatment

Let us understand how each of these parameters is different for liquid mutual funds and fixed deposit:

  • Risk

    One of the most important factors in case of any investment is the risk associated with it. FDs are considered to be no-risk investments whereas investing in mutual funds carries a certain amount of risk associated with market volatility.

  • Availability of funds

    An investment in FD should be made in a lump sum whereas mutual funds allow an investor to set up a systematic investment plan (SIP) and invest a certain amount each month. This will build financial discipline and diversify the risk of the portfolio.

  • Returns

    FDs carry a pre-specified rate of return, which does not change during the entire period of investment. Higher the tenure, higher the rate of interest. For a lower tenure, the interest rate is also low. Mutual fund returns are not based on a fixed rate of return. The return on investment (ROI) is affected by the ups and downs in the market. Equity mutual funds are known to carry a higher level of risk while debt funds carry a lower risk.

  • Liquidity

    Fixed deposits have a fixed tenure. It carries very low liquidity until the end of the tenure. In other words, if you break an FD before its maturity, a penalty will be charged and you may have to forego a part of your earnings. However, post the tenure, the entire principal and interest may be credited to your savings or current account within an hour. On the contrary, mutual funds returns may be redeemed at any point in time with an exit load.

  • Tax treatment

    One major factor on which investors weigh the investment options is the tax treatment. In case of FDs, the tax is levied as per the current tax slab of the investor. In case of liquid funds, the dividend received is tax-free. The impact of gain or loss on mutual fund depends on the type of fund. For equity funds, the short-term capital gain is taxable at 15% and the long-term gain is tax-free. For debt funds, the short-term capital gains are taxed according to the income slab of the investor and the long-term capital gain is taxed at 20% with indexation and 10% without indexation.

The table below shows a quick comparison between the Fixed Deposits and Mutual Funds:

Parameter Fixed deposits Mutual funds
Risk Low risk Medium to high risk
Return Fixed pre-specified return No guaranteed return; depends on market conditions
Liquidity Medium to high liquidity High liquidity
Tax treatment As per the tax slab Favorable tax status for long-term investment
Withdrawal Allowed with a penalty Allowed with an exit load

 

Considering the various aspects of both the investment options, it may be concluded that mutual funds fare better than FDs. If an investor has a higher risk appetite and prefers to invest for a long tenure, investing in mutual funds will give a higher return. For individuals who do not want to take any risk and only seek a pre-specified return, FDs will be ideal.

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