Comparing Fixed-Income Investments: FD Vs Bond Vs Mutual Fund
Introduction:
With the availability of online investment platforms and increased awareness among investors, equity investments are becoming popular by the day. The Indian equity markets have experienced a steep surge in retail investor involvement since the COVID-19 pandemic. However, it’s crucial to note that equity-based instruments – such as stocks and mutual funds – are suitable only for investors with a high risk tolerance.
More conservative investors, who do not wish to expose their funds to market volatility, may find investing in fixed-income avenues a more suitable option. Even aggressive investors can benefit from including fixed-income instruments in their portfolio to mitigate overall risk.
Bonds vs FDs vs Debt Mutual Funds
If you are also considering adding some fixed-income instruments to your investment portfolio, you may encounter various choices such as bonds, fixed deposits, and debt mutual funds. These are the three most common fixed-income avenues available in India.
Investing in bonds and fixed deposits allows you to lend your money to a bank or corporate entity at a specific rate of interest. Thereafter, you earn a periodic interest on your investment, which is returned to you on maturity. On the other hand, debt mutual funds allow you to make lump sum or SIP investments in a mutual fund scheme and get risk-free returns.
Now, you might be wondering whether you should put your money into a fixed deposit, a bond, or a debt mutual fund scheme. This article presents a comprehensive comparison of the three popular fixed-income investment vehicles to help you choose the right one as per your requirements. Keep reading.
Understanding bonds
Bonds are debt securities issued by corporations, municipalities, or government entities to raise capital. When you invest in a bond, you typically lend money to the issuer in exchange for periodic interest payments at a pre-determined rate (known as the coupon rate) and the return of the principal amount at maturity.
Bonds offer a wide range of options regarding issuer credit quality, maturity periods, and interest rate structures. They can range from highly secure government bonds to riskier corporate bonds offering higher yields.
The advantages of investing in bonds include:
- Regular and predictable income stream
- Potentially higher returns than FDs
- Portfolio diversification
- Nominal to zero risks
- Offers high liquidity
The disadvantages of bonds include:
- The returns may vary as per the inflation rate and the repo rate
- Corporate bonds may vary significant risks
- Lower returns as compared to stocks
Understanding Fixed Deposits
Fixed Deposits are one of the most traditional and widely used forms of fixed-income investments. They are offered by banks, post offices, and non-banking financial institutions and typically come with a fixed interest rate and a predetermined maturity period. They allow you to deposit a certain sum of money for a specific tenure, and in return, receive a fixed amount (principal + interest) upon maturity.
The advantages of fixed deposits include:
- Provide guaranteed returns at maturity with minimal risks
- Easy to invest and manage
- You can get a loan against a fixed deposit
- Five-year fixed deposits provide tax benefits under section 80C
The disadvantages of fixed deposits include:
- Interest rates are fixed for the entire tenure
- Returns are lower than stocks and other instruments
- Low liquidity and penalty on pre-mature withdrawal
Understanding Debt Mutual Funds
Debt Mutual Funds pool money from several investors and invest in multiple fixed-income securities such as government bonds, corporate bonds, money market instruments, and other debt instruments. Professional fund managers manage these funds and make investment decisions based on market conditions and investment objectives.
The advantages of debt mutual funds include:
- Potentially higher returns than fixed deposits and other fixed-income instruments
- The expertise of professional fund managers
- Good option to diversify your investment portfolio
- Less risky as compared to equity mutual funds and stocks
- Option to invest via lump sum or SIP
- High liquidity
The disadvantages of debt mutual funds include:
- Returns are not fixed and can fluctuate
- Interest rate risk, credit risk, and liquidity risk
- Exit load may be applicable
To conclude
Choosing between FDs, Bonds, and Debt Mutual Funds ultimately depends on your investment goals, risk tolerance, and time horizon. Each instrument has its own set of pros and cons, and there is no one-size-fits-all solution.
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