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Investing your hard-earned money wisely is essential for building wealth, achieving financial goals. With so many options available, it can be hard to decide where to place your money.
As a Certified Financial Planner (CFP) the most common question we hear is:
“Should I invest in Fixed Deposits (FDs) or Mutual Funds (MFs)?”
While FDs have been a traditional favorite among Indian investors, investment planning today requires looking beyond fixed-income instruments to beat inflation and secure financial growth.
So, which one is the better option…?
Understanding Inflation & the Need for Growth
People are now realizing that in order to beat inflation & meet their goals, they need to look beyond the traditional investment options. Let’s first understand inflation, which is a key factor in why investments need to outpace fixed returns.
Which one would you prefer…?
What is Inflation?
Inflation is the rise in the prices of goods and services over time, which reduces the purchasing power of money. In simple terms, it means that things will cost more in the future than they do today.
Why Fixed Deposits (FDs) Struggle with Inflation?
Fixed Deposits (FDs) are a straightforward investment option designed to offer low-risk, predictable returns. They provide interest at fixed intervals—monthly, quarterly, semi-annually, or annually—ensuring a stable income stream. However, FDs are not designed to outpace inflation.
Fixed Deposits (FDs) have a limitation – they are not effective in building long-term wealth.
Let’s assume the following:
- FD Interest Rate: 7% per annum
- Mutual Fund Return: 12% per annum
- Inflation Rate: 6% per annum
- Tax Rate: 30% (assumed highest income tax slab)
Imagine that you want to purchase a Pen which costs Rs. 100 today. However, taking inflation into account, the same pen would cost Rs. 106 next year.
1. Fixed Deposit (FD):
A. FD Returns (Before Tax)
- Investment: Rs. 100
- Interest Earned = Rs. 100 × 7% = Rs. 7
- Total Amount After 1 Year (Before Tax) = Rs. 100 + Rs. 7 = Rs. 107
B. Tax on FD Interest
Since FD interest is taxable, and the investor is in the 30% tax bracket:
- Tax on FD Interest = Rs. 7 × 30% = Rs. 2.1
- Post-Tax Interest = Rs. 7 - Rs. 2.1 = Rs. 4.9
- Total Amount After 1 Year (Post-Tax) = Rs. 100 + Rs. 4.9 = Rs. 104.9
C. Impact of Inflation on FD Investment
Now, let’s account for the 6% inflation rate:
- Inflated Price of the Pen = Rs. 100 × 1.06 = Rs. 106
- Real Value of Your Investment After Tax = Rs. 104.9
- Real Return After Inflation = Rs. 104.9 - Rs. 106 = - Rs. 1.1 (negative)
2. Mutual Fund:
A. MF Returns (Before Tax)
Now, for a Mutual Fund with a 12% annual return:
- Investment: Rs. 100
- Interest Earned = Rs. 100 × 12% = Rs. 12
- Total Amount After 1 Year (Before Tax) = Rs. 100 + Rs. 12 = Rs. 112
B. Tax on Mutual Fund Returns (LTCG Tax of 12.5%)
The tax rate on long-term capital gains (gains from equity mutual funds) is 12.5%.
- Capital Gains Tax on Mutual Fund = Rs. 12 × 12.5% = Rs. 1.5
- Post-Tax Mutual Fund Return = Rs. 12 - Rs. 1.5 = Rs. 10.5
- Total Amount After 1 Year (Post-Tax) = Rs. 100 + Rs. 10.5 = Rs. 110.5
C. Impact of Inflation on Mutual Fund Investment
Now, let’s account for the 6% inflation rate:
- Inflated Price of the Pen = Rs. 100 × 1.06 = Rs. 106
- Real Value of Your Investment After Tax = Rs. 110.5
- Real Return After Inflation = Rs. 110.5 - Rs. 106 = Rs. 4.5
Comparison of FD vs. Mutual Fund
Investment Type |
Nominal Return (Before Tax) |
Post-Tax Return |
Real Return After Inflation |
|---|---|---|---|
|
Fixed Deposit
|
7%
|
4.9% |
-1.1% (negative) |
|
Mutual Fund
|
12%
|
10.5%
|
+4.5% (positive)
|
This means your purchasing power is actually decreasing despite earning interest, making FDs unsuitable for long-term wealth creation.
The Impact of Compounding
Rs. 1 Lakh invested in Fixed Deposit Vs. Mutual Fund
Compounding rewards patience – the longer the investment horizon, the greater the benefits of the investments.
Thus, for long-term wealth creation, retirement planning, high-growth potential, mutual funds offer superior wealth creation potential compared to traditional fixed deposits.
“If you need safety and short-term liquidity but also aim for superior long-term wealth creation, a balanced strategy would be to keep your emergency corpus in FDs while investing your surplus income in Mutual Funds. This approach ensures financial stability while maximizing growth potential to achieve your long-term goals.”
For Personalized Investment Planning, consult a Certified Financial Planner (CFP) or Financial Advisor to align your investments with your financial aspirations.
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– Shrees Haralkar, Associate FP.