Mutual Funds4182 views
What does one seek from an investment? It could be liquidity, return on investment or the accumulation of a large corpus to fund long term financial goals like retirement or purchase of a home. The ones with a lesser appetite for taking a risk would mostly go for fixed deposits as they guarantee the safety of the invested capital. But on the returns front, there is a major catch, the interest rates on FD accounts have fallen sharply to as low as 5% from the highs of 8%-9% a year back! And eventually, post-tax, the returns become abysmal. Add to the inflation pressure, you could actually lose value with a fixed deposit.
So, in a situation like this which is that one product that can provide liquidity, good returns and a big corpus? Without any doubt, it would have to be a mutual fund.
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So, what is a Mutual Fund?
In simple words, it collects money from individual investors and invests that accumulated capital in a pool of different companies. It invests in a myriad of equity and debt instruments to keep the rate of risk lower. It has a wider classification of funds – broadly categorized as equity funds, debt funds and balanced funds – catering to the unique requirement of various types of investors. And the best way to start with mutual funds is via a Systematic Investment Plan (SIP), which has offered an average return of over 20% in equity schemes for a period of around 15 years. And in comparison, fixed deposits have provided slightly over 9% in the last 20 years. Even debt funds can give a return of 7%-9% on a year-to-year basis while providing liquidity at the same time.
Point-to-Point Comparison Between Mutual Funds SIP and Fixed Deposit
|Parameters||Mutual Funds SIP||Fixed Deposit|
|Returns||No assured returns||Returns dependent on the interest rate prevailing from time to time|
|Scope for Inflation-adjusted Returns||High||Low|
|Form of Return||Capital gain and dividends||Interest|
|Liquidity||Higher Liquidity||Low to medium liquidity|
|Risk||Low to High Risk, depending on the type of fund chosen||Low Risk|
|Mode of Investment||Periodical- Daily, Weekly, Fortnightly, Monthly, Quarterly, Half-yearly or Annually||Lump-sum mode of investment|
|Professional Expertise||You have the fund manager to take care of your SIP investment||No such professional expertise deployed for fixed deposit|
|Market Timing||Eliminates the need for market timing with Rupee Cost Averaging||Market timing is vital here|
|Tax Implication||No capital gain tax charged if the equity mutual fund units are sold after a year. A 15% tax will be levied on selling the investment before a year. |
Debt funds, if get sold after 3 years, will be taxed at 20% with indexation and 10% without indexation. Selling the funds before 3 years will attract tax rate as per the individual tax slabs of the investor
|Tax will be levied as per the income tax slab of an individual|
|To Suit Whom||Both Conservative and aggressive investors||Only conservative investors|
Modus Operandi of SIP & Fixed Deposit
An SIP is a disciplined form of investment, which requires one to invest a specific sum of money at predetermined intervals. The investment amount can be as low as ₹500 on a monthly basis. On the other hand, fixed deposit is a lump-sum investment of money in banks or financial institutions for a certain period of time. The minimum deposit amount is about ₹5,000.
SIP Outperforms Fixed Deposit with Rupee Cost Averaging
An SIP eliminates the need for timing the market by virtue of rupee-cost averaging as stated in the table above. Investors tend to be reluctant while investing in a falling market, while many perceive it to be too costly to invest during a bull run. An SIP eases these concerns. When the market goes down, a higher number of units are bought at a lower price. Similarly, fewer mutual fund units are purchased at a higher price when the market goes up. In this way, the average cost of the investment comes down. On the other hand, fixed deposits do not provide such cushion to the investors. So, if you are looking to invest for the future, it’s better to pick an SIP over a fixed deposit.
Power of Compounding to Work More in the Case of Mutual Fund SIP
The ‘Power of Compounding’ is another strong point an SIP provides to build your corpus. The money tends to grow exponentially over time with compounded returns. However, to take full advantage of the compounding factor, it is indeed vital to go for a long-term investment.
Example – if you invest in an equity mutual fund via SIP installment of ₹5,000 on a monthly basis, you can expect the corpus to grow to 25 lakhs in 15 years time at an assumed annual return of 12%. The total amount to be invested in 15 years equals to ₹9 lakhs, giving you a wealth surplus of around ₹16 lakhs.
Meanwhile, a fixed deposit of ₹1 lakh for 15 years could give you a sum of little more than ₹2 lakhs (pre-tax) at the time of maturity, based on the prevailing interest rates of 5%-6%. So, there is clearly a huge difference between the two.
On most counts, mutual funds have an upper hand over fixed deposits. Also, SIPs are likely to appeal to a wide range of investors having varied risk-appetites, they tend to outweigh the fixed deposits in a big way. The inflation could make the fixed deposit value redundant at the time of maturity.
Disclaimer – Mutual Funds are subject to market risks. Please read the scheme related documents carefully before investing.