Fixed deposits and debt mutual funds: Which is better?

Fixed Deposit or Debt Mutual Fund

Fixed Deposit or Debt Mutual Fund

As the capital gains on debt funds units purchased after April 1, 2023, become taxable at the slab rate, many investors would think that debt funds come at par with fixed deposits. However, it is not the case. A careful look at both these instruments will help you to choose the right one to reach your financial goals.


The returns on FDs are assured, and so it is with bonds. Anup Bhaiya, Founder of Mumbai-based Money Honey Financial Services, says, “Repricing of interest rates gets captured in debt funds faster, as bond yields in the secondary market tend to react to changes in interest rates in the economy quickly. The interest rates on FDs generally act with a lag.”

Debt funds do not offer assured returns. Market forces, changes in interest rates, changes in portfolio mix by the fund manager, and other factors can change the returns on debt funds. For example, long-duration debt funds may see returns going up when there is a big fall in interest rates in a short span of time. The capital gains on bonds held in the portfolio can boost returns. In a rising interest-rate scenario, such schemes may see muted returns.

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“Debt funds can give you mark-to-market gains if you invest at the peak of the interest rates and rates come down swiftly,” Bhaiya adds.


FDs from nationalised banks or sovereign-backed entities, such as India Post, have little credit risk. So is the case with bonds issued by sovereign and public sector undertakings. However, as one goes in search of high yields, credit risk may creep in.

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Priyadarshini Mulye, a SEBI-registered investment advisor and founder of, points out that bank FDs are insured to the extent of Rs 5 lakh for the principal and the interest by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

“Due to changes in the interest rates in the economy, investments in bank fixed deposits face reinvestment risk,” she adds.

Debt funds face credit risk, interest rates risk, and reinvestment risk. Investors need to check the risk-o-meter of the scheme to get an idea of the current level of risk the scheme portfolio is exposed to. Also, the potential risk class matrix clearly explains the maximum duration risk and the maximum credit risk the fund manager can take.

Depending on the risk-taking ability the investor may choose various schemes. For example, those who are keen to avoid credit risk may choose to invest in gilt funds and those who want to avoid interest rate risk may want to stick to debt funds investing in short-term instruments – like overnight funds, liquid funds.


Check liquidity. If you need money urgently, how soon can you get it?

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FDs allow you to withdraw money, of course with penalty. When you need money before the due date, you have to break the entire FD. Only high-quality bonds get traded in the secondary market near fair value. In case of low-rated bonds, interim liquidity can be a challenge even if the bond is listed in the secondary market.

For example, investors in bonds with ‘AA’ ratings and below may find it difficult to sell their bonds in the secondary market. In case of debt funds, you can redeem the units and you are paid within two days, subject to exit loads, if any. You can redeem as much as you want to.


When you are signing up for a fixed deposit, the rate of interest on offer depends on the tenure you are willing to keep the money with the issuer. In case of debt funds, the fund manager decides the duration of the portfolio in line with the scheme’s objective. You can remain invested as long as you want, in case of open-ended schemes.

For example, though a low-duration fund offers a portfolio with a duration of 6-12 months, you may choose to remain invested in it as long as you want. In case of target maturity funds and fixed maturity funds, the money hits your account after the scheme matures.

When you are building a portfolio of fixed deposits or bonds, you may want to diversify across issuers. This may not be easy as not many individuals can assess the credit risk involved. Investors, however, can ladder the fixed deposits by investing across maturities.

In case of debt funds, investors get access to a diversified portfolio of bonds, and, if they are keen, they can invest in schemes that invest across maturities. For example, you can take exposure to short-, medium- or long-duration funds, depending on your view on interest rates or you can invest in a dynamic bond fund and let the fund manager decide the duration of the portfolio.


There are no direct costs associated with investing in fixed deposits. In the case of bonds, the cost of demat accounts need to be accounted for. Debt mutual funds charge a recurring expense ratio, which may range between a few basis points to around one percentage point, depending on the product you choose.


Interest on fixed deposits and bonds are subject to tax deduction at source. You may opt for cumulative interest payout at maturity and you have the option of paying tax thereon — at the time of maturity. But the interest-paying entity deducts tax at source on an accrual basis, and carrying forward TDS till the time of maturity is an administrative hassle.

Further, the income-tax department may question the individual due to the mismatch between the income offered to tax and income reported to the department. That makes most investors go for accrual-based reporting of income in interest-paying instruments, which may not be an attractive idea for someone keen on long-term compounding of money in fixed income.

Debt funds are neither subject to TDS rules on accrual basis nor there is tax liability till the time of redemption. The investor is supposed to pay tax as per slab rate, only when he sells units of debt funds.

“From FY 2023-24, gain or loss from debt MF will always be short term. As per the income tax provisions, short-term loss from any capital asset can be set off against short-term as well as long-term gains from any capital asset. But in case of gains from debt MF, investors have to be careful. Short-term gains from debt MF can be set off against short-term loss from any class of capital asset,” says Mihir Tanna, Associate Director, SK Patodia and Associates.

What should you do?

Investors must not ignore the fact that both FDs (and bonds) and debt funds are fixed-income vehicles. Both are unlikely to beat inflation in the long term. Both these vehicles are considered relatively conservative investments. Lenders are willing to extend loans against both.

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Parul Maheshwari, a Mumbai-based Certified Financial Planner, says, “There is higher visibility of returns in fixed deposits as you know what you will get on maturity, and, hence, it is better suited for retail investors to achieve their financial goals.” Investors in lower income-tax slabs and near-term financial goals are more likely to find fixed deposits more attractive.

She advises taking a holistic view, keeping in mind the risks involved, liquidity and return expectations, and to not rely on any one factor while choosing investments.

Ultimately, prioritise your financial goals over tax compulsions, and then take a call. Some investors are diligent and reinvest every rupee of interest earned. However, some end up spending the interest, which deprives them from the benefits of compounding. Debt funds, however, help avoid such leakages.