While a fixed deposit can guarantee you a fixed income, the returns are substantially lower in comparison to a similar investment made in mutual funds. A comparative analysis will present a clearer picture.
When you invest in an FD, banks lend the money to businesses in the form of a loan. And when you invest in equity mutual funds, then the asset management company (AMC) further invests the accrued funds in the stock market to buy equities. Whichever is the way of investment, ultimately, the money is getting invested in the businesses, and your funds have a credit risk associated with it.
On the one side, when people invest in a bank FD, they feel relaxed. They do not have to worry about the risks associated with the investment. However, on the other side, when they invest in mutual funds (MFs), they feel that their money is at risk.
The fact is that be it FDs or MFs, the money is lent to others, and there is always a risk associated with it. If you compare the returns of large cap equity mutual funds with that of bank FDs, the difference is huge. Therefore, we must understand the risk associated with both the investment instrument in greater details.
Why fixed deposits?
First, let us understand how FDs are safer than mutual funds:
- Portfolio diversification: Banks have diversified portfolios as they lend not only to the businesses but also to retail customers. Banks have multiple forms of loans to attract maximum customers, such as personal loans, home loans, two-wheeler/four-wheeler loan, etc. Whereas, equity mutual funds generally invest in top 25-100 companies. On the other side, banks have millions of customers under their ambit.
- Insurance on FD: Every FD is insured by the DICGC (Deposit Insurance and Credit Guarantee Corporation), which is a wholly-owned subsidiary of the Reserve Bank of India (RBI). However, this insurance covers a maximum amount of Rs 5 lakh. That means, in case a bank defaults, DICGC is liable to pay you the FD amount (only up to Rs 5 lakh).
- Returns are guaranteed: There are no market risks associated with FDs. Hence, the returns are guaranteed by banks.
The risk in mutual funds
Credit Risk: If you invest in largecap mutual funds, these funds invest the accrued amount in the top 20-50 listed companies of India. To understand the real worth of these companies, let us understand the concept with an example of Nifty50, which represents the leading 50 companies of the Indian stock market.
The market cap (capitalisation) of these top 50 companies is Rs 113.5 lakh crore, which is almost 60 percent of the Indian gross domestic product (GDP). These companies come from 14 different sectors such as automobiles, pharma, banks etc, and these are the top companies of their respective sectors. In fact, the Indian economy has a huge dependency on these companies, so it is next to impossible that all these companies will default at the same time, and your investment goes down the drain.
Market Risk: As you might have heard on a daily basis that mutual funds are subject to market risk. Actually, they are. However, if you stay invested for at least ten years, Nifty 50, a leading benchmark of share market performance, has never given negative returns.
In the last 20 years, it has given an average compound annual growth rate (CAGR) of 12.3 per cent and a minimum CAGR of 5.5 per cent (almost current FD rates) on a ten-year investment horizon. Therefore, if you are investing for the long-term, you can rely on the stock market.
Let’s say, if you invest Rs 1 lakh for ten years, an FD will pay you Rs 1.79 lakh (assuming 6 per cent returns). However, if you invest the same amount in large cap mutual funds, it will become Rs 3.40 lakh (assuming 13 per cent returns, which is the average of all largecap mutual funds return in 5 years). This is almost 190 per cent of FD returns.
Conclusively, you must make an investment decision keeping all the above-mentioned factors in mind because investment in an FD is secure than mutual funds, but the cost of this safety is huge, and returns are abysmally low.
(Ravi Singhal is Vice-Chairman of GCL Securities Limited)
