Fixed Deposits vs Debt Funds: What’s the better investment in 2024?

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Stable returns at low risk make fixed deposits and debt funds two of the best short term investment options.

While both share some similarities like predictable returns and tax treatment, they are different in many other ways.

For example - Fixed deposits are insured up to Rs. 5 lakh per depositor per bank, but debt funds are not.

In this article, we look at all the differences between fixed deposits and debt funds to help you identify the better fixed income instrument for your needs.

Fixed Deposits Offer Fixed Returns, Debt Fund Offer Fluctuating Returns

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When you invest in a fixed deposit you know exactly the returns you will generate and can calculate the maturity amount easily. On the other hand, debt funds don’t offer fixed returns.

This is because debt funds are portfolios of fixed income securities like bonds which are actively traded like stocks and have different prices each day.

However, debt funds offer fairly stable returns compared to assets like stocks, real estate, gold etc. Here’s how you can estimate the annual returns of any debt fund:

Go to a mutual fund research website like Valueresearch

Search for the debt mutual fund scheme you are interested in

Find out the Average Maturity and Yield to Maturity of the scheme

Here’s what these numbers look like for HDFC Corporate Bond Fund (not a recommendation):

Source: Valueresearch | As of 2 April, 2024

This means that if you invest in the fund for 5.06 years, you can expect to generate an annual return of 7.76%.

In reality, it will be lower/higher than 7.76%, but this is the most reliable estimation of your returns.

Fixed Deposits are Insured up to Rs. 5 Lakh, Debt Funds are Not

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DICGC* insures bank deposits up to Rs. 5 lakh per bank account. This means if there’s a problem with the bank and it is unable to return your deposits to you, DICGC will step in and return your money.

*DICGC (Deposit Insurance and Credit Guarantee Corporation) is a subsidiary of the RBI (Reserve Bank of India)

This means the already safe fixed deposits are virtually risk-free up to Rs. 5 lakh. Hence, at Altcase, we believe that investors can simply invest in the highest rate DICGC-insured FD irrespective of the bank offering it.

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In contrast, debt funds don’t enjoy any insurance from any party.

Fixed Deposits Help You Save Tax, Debt Funds Don’t

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Tax-saving fixed deposits are an eligible instrument under IT Section 80C which offers tax deductions of Rs. 1,50,000.

Instruments like PF, PPF, ELSS mutual funds etc. are some other eligible instruments under IT Section 80C.

Tax deductions help you reduce your taxable income and hence tax liability. So, if you invest Rs. 1,50,000 in tax-saving fixed deposits, your taxable income will be Rs. 1,50,000 lower.

Let’s say your gross taxable income is Rs. 20 Lakh and you invest Rs. 1,50,000 in tax-saving FDs, then your taxable income will become Rs. 18.5 Lakh. Considering that this Rs. 1,50,000 would have attracted ~30% tax, you would pay ~Rs. 45,000 lower tax for that financial year.

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Debt funds don’t offer any tax deductions or tax breaks to their investors.

Fixed Deposits are More Reliable to Generate Regular Income

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Investors who seek to generate regular income from their investments should prefer fixed deposits over debt funds.

Fixed deposits are flexible in terms of interest payouts with frequencies like fortnightly, monthly, quarterly and yearly. Moreover, you will know exactly what amount you will receive when you invest in the FD.

Here’s Why Income From Debt Funds is Unreliable

Debt funds also have the provision to distribute income but it is not as reliable as fixed deposits because of three problems:

Frequency of income - Unlike FDs, the income frequency is not predetermined in case of debt funds. It is up to the fund management team’s discretion.

Quantum of income - Unlike FDs, the quantum of income you will receive in case of debt funds is unknown. If the fund management does distribute income, the amounts may fluctuate and cause inconvenience if you rely on this income.

Source of income - In case of FDs, the income you receive is interest generated by your investment. However, debt funds can pay you income that may come out of your investment in the fund and not necessarily the money the fund has generated.

Income Generation is Optional

Income generation is optional in both fixed deposits and debt funds.

You may choose to invest in a ‘cumulative fixed deposit’ where all the interest generated is paid out at maturity. Similarly, you can invest in ‘growth options’ of debt funds where all the income generated by underlying securities gets reinvested and can be redeemed at your discretion.

Fixed Deposits Offer Higher Interest to Senior Citizens, Debt Funds Don’t

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Most banks and NBFCs (Non-Banking Financial Institutions) that offer fixed deposits with slightly higher interest rates to senior citizens.

Seniors of our society heavily rely on their savings to sustain themselves and this little incentive goes a long way. It also benefits the financial institution to retain a client and utilise their deposits for their operations.

Senior citizens can expect to be offered an additional interest rate of 0.25%-0.50% if they sign up for fixed deposits with a financial institution.

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Debt funds, on the other hand, don’t offer any such incentives to senior citizens.

Considering the reliability of fixed deposit as an income generating instrument and the higher interest rate for investors over the age of 60, fixed deposit is a no-brainer for senior citizen investors.

Fixed Deposits Offer Tax Breaks to Senior Citizens, Debt Funds Don’t

The benefits for senior citizens don’t stop with additional interest rates.

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Under the specially drafted IT Section 80TTB, interest income of up to Rs. 50,000 generated from deposits of up is tax exempt every financial year.

The Rs. 50,000 exemption considers all deposits like, but not limited to savings bank accounts, bank fixed deposits, recurring deposits, post office deposits etc.

This is yet another advantage that makes fixed deposits a clear winner over debt funds for senior citizens.

Borrowing Against FDs is More Affordable than Borrowing Against Debt Funds

You can borrow money or take loans either without collateral (like personal loans) or by pledging securities like an FD, stocks, mutual funds etc.

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The advantage of borrowing against securities like FDs and debt funds is that the bank will demand a lower rate of interest than it would on a personal loan.

However, when you borrow against securities, the interest rate demanded by the bank depends on the security.

Interest Rate on Loan Against FDs:

As of April 2024, SBI charges a 1% higher interest rate than the FD you are borrowing against. So, if you borrow against an FD that promises to pay an 8% interest rate, SBI will charge you a 9% interest rate.

Interest Rate on Loan Against Debt Funds:

If you choose to borrow against your debt mutual funds, SBI demands an interest rate of 11.15%.

Borrow More Against FDs:

The loan amount each security is eligible for also differs.

If you borrow against fixed deposits, you can get a loan of up to 90-95% of the fixed deposit value. However, if you borrow against debt funds, you can get a loan of around 75-80% of the investment value.

All in all, it is more logical to borrow against FDs than to borrow against debt funds.

Fixed Deposits Offer Sweep-in Facility, Debt Funds Offer SIP Facility

Investing in FDs and debt funds is largely a manual process.

You need to place an order on your mobile and make payment every time you want to invest in an FD or debt fund.

However, certain facilities exist that allow you to automatically invest in FDs as well as debt funds based on certain rules.

FD Sweep-in Facility

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The ‘sweep-in facility’ helps you automatically transfer excess amounts in your savings account to a fixed deposit.

Let’s say you activate the sweep-in facility such that amounts in excess of Rs. 50,000 in your savings account will get automatically deposited into FD.

Suppose you have Rs. 40,000 in your savings account and receive an inflow of Rs. 20,000 taking your savings account balance to Rs. 60,000. Now the sweep-in facility will get triggered and automatically invest Rs. 10,000 in FD.

Debt Mutual Fund SIP

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Automatic investments are possible debt mutual funds through the SIP (Systematic Investment Plan) facility.

All you need to do is select an investment amount, a monthly date and set up a bank mandate to start an SIP in your choice of debt fund(s).

Debt Funds Charge Management Fees, Fixed Deposits Don’t

When you invest in a debt fund, you are essentially appointing a professional fund manager to invest your money. This fund manager pools your money along with the monies of other investors who invest in his fund and manages it.

This professional service doesn’t come for free.

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Each debt fund charges a management fee called total expense ratio (TER). TER is calculated as a percentage of your investment value and is generally between 0.25-0.75% per year.

You are not required to pay the TER separately rather it is deducted from your investment value by the debt fund regularly.

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On the other hand, there is no such management fee or any other fee involved when you invest in fixed deposits.

Debt Funds are Exposed to More Risks Than Fixed Deposits

Like equity/stocks, even fixed income instruments like FDs and debt funds are exposed to various types of risks.

Here is how different types of risks affect bank FDs and debt funds:

Risk	Fixed Deposits	Debt Funds	Notes
Credit default risk (the risk of the borrower not returning your money)	Low	Low to high (varies across types of debt funds)	Bank deposits are insured by DICGC, an RBI subsidiary up to Rs. 5 lakh per account holder per bank
Liquidity risk (the risk of not being able to convert the asset into cash quickly)	Very low	Very low	Debt funds manage liquidity risk at their end
Price risk (the risk of change in asset’s price because of market conditions)	Nil	Low to high (varies across types of debt funds)	FDs have no exposure to price risk while debt funds of all types are exposed to it
Reinvestment risk (the risk that when the asset matures, the market interest rates will be lower)	Moderate	Low	Debt fund portfolios are dynamic and can tackle reinvestment risk better than FDs
Fund manager risk (the risk that wrong decisions will lead to suboptimal returns)	Nil	Low to high (varies across types of debt funds and fund manager experience)	FDs have no exposure to fund manager risk as there is no fund manager involved
Inflation risk (the risk that your returns will be lower than inflation)	Low to high	Low to high	Depends on many factors like choice of instrument, investment tenure and your tax bracket

Fixed Deposits Attract TDS, Debt Funds Don’t

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Whenever your FD earns interest, it is credited to you after deducting a TDS (tax deducted at source).

Here are 3 things to know about the TDS on interest on FDs:

TDS is deducted if the FD interest for the year is more than Rs. 40,000 for individuals and more than Rs. 50,000 for senior citizens

If your PAN is linked to your FD, a TDS of 10% is deducted. A TDS of 20% is deducted if PAN is not linked

If your annual income level doesn’t attract tax, you can submit form 15G (non-senior citizen) or form 15H (senior citizen) and instruct the bank to not deduct TDS from interest payments for that financial year

It is important to note that TDS on interest credits may not be the only tax FDs attract. The total interest you earn from your FD is added to your annual income and taxed accordingly. So, it may be taxed at 30% or 39% if your annual income is high.

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Debt funds don’t attract TDS for resident investors irrespective of their age. In fact, debt funds don’t attract taxation until you withdraw your money from them.

Debt Funds are Diversified, Fixed Deposits are Not

Debt funds are portfolios composed of fixed income securities like government bonds, corporate bonds, commercial papers, debentures etc.

Each debt fund invests in up to dozens of such securities thereby diversifying your investment in the fund.

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Diversification offered by debt funds reduces your risk exposure to a single fixed income security and is a great benefit.

However, when you invest in a fixed deposit, the risk exposure is concentrated to the financial institution offering the FD.

However, the risks associated with RBI regulated entities that offer FDs is inherently low. FD investors are further protected as bank deposits of up to Rs. 5 lakh per depositor are insured by DICGC, an RBI subsidiary.

Debt Funds Offer Penalty-free Exit, Fixed Deposits Generally Don’t

Mutual funds may levy a penalty called ‘exit load’ if you withdraw within a certain period of investing in it. However, this is a feature of equity mutual funds rather than all mutual funds.

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Most debt funds have a 0% exit load and allow you to redeem your money any time you want.

Note: Liquid funds, a popular debt fund category, has exit load applicable for the first 7 days after your investment.

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Fixed deposits, although easy to withdraw, attract a penalty of around 1-2% if you withdraw prematurely.

Note: The penalty will not be charged on your principal/investment. Your FD will just generate a lower interest rate (and hence amount) than it would have generated had you allowed it to mature.

Debt Funds are Offered by AMCs, Fixed Deposits are Offered by Banks and NBFCs

Debt funds are offered by Asset Management Companies who appoint fixed income investment experts to manage your money.

AMCs are profit making businesses who make money by charging you an ‘expense ratio’ (a management fee) for managing your money.

Fixed deposits, on the other hand, are offered by financial institutions like banks who need money for their business operations - primarily, lending.

Financial institutions in the business of lending collect deposits from you and loan it to home loan, car loan and other loan borrowers. The difference in the interest rate they pay you and the interest rate they collect from borrowers is how they generate profit as a business.

Debt Funds are Regulated by SEBI, Fixed Deposits are Regulated by RBI

SEBI (Securities Exchange Board of India) regulated AMCs and hence debt funds.

On the other hand, financial institutions eligible to offered fixed deposits are regulated by the RBI (Reserve Bank of India). As an extension, fixed deposits are also regulated by the RBI.

Fixed Deposits vs. Debt Funds: At-a-Glance Summary

Aspect	Fixed Deposits	Debt Funds
Nature of return	Fixed	Fluctuating but stable within a range
Insurance	Insured up to Rs. 5 lakh by DICGC, an RBI subsidiary	No such insurance
Tax saving feature	Certain 5-year FDs are eligible under IT Section 80C that helps you lower your taxable income by up to Rs. 1.5 lakh	No such tax saving feature
Reliable regular income	Very reliable and option to choose from different frequencies	Not reliable
Senior citizen benefits	Senior citizens enjoy higher interest rate than others as well as higher tax exemptions on annual interest from deposits	No special benefits to senior citizens
Collateral quality	Borrowing against FDs is more affordable than debt funds	More expensive than FDs
Regular investing	FDs offer sweep-in facility that may result in regular investing	SIPs are great to regularly invest in debt funds
Management fees	FDs are managed by banks and don’t have a fee	Debt funds have a fee called ‘expense ratio’ that is auto deducted
Investing risks	FDs are exposed to fewer risks than debt funds	Debt funds are exposed to more risks than FDs
TDS (Tax Deducted at Source)	FDs may attract TDS at higher interest amounts	Debt funds don’t attract TDS
Diversification	FDs expose your money to only one financial institution and hence are not diversified	Debt funds invest your money in a basket of fixed income securities and hence diversified
Penalty on exit	Financial institutions may charge a penalty of 1-2% if you withdraw prematurely	Most debt funds don’t charge a penalty on exit
Provider and regulator	FDs are provided by financial institutions like banks and NBFCs that are regulated by the RBI	Debt funds are provided by asset management companies that are regulated by the SEBI

Fixed Deposits vs. Debt Funds: Frequently Asked Questions (FAQs)

Should you invest in fixed deposits or debt funds?

As of April 2024, fixed deposits seem like the better investment option purely from the return perspective. Many fixed deposits offer interest rates upwards of even 8%. However, the average yield to maturity across debt funds is ~7.4% (Source - Valuresearch). Some debt funds do offer yield to maturity as high as 9% but they also come with substantially higher risks.

Considering that many FDs are offering high returns and are insured up to Rs. 5 lakh by an RBI subsidiary, they look like the more attractive investment option in 2024.