When comparing FD vs Debt Mutual Funds – two different investment types, investors should clearly understand the difference between mutual funds and fixed deposits. For the term of the deposit, the fixed deposit interest rate is fixed. Regardless of what happens to interest rates in the economy, there will be no change in the fixed deposit interest rate during the term of the deposit. In contrast, mutual funds invest in market securities. Consequently, mutual funds are subject to market risks. The security price in the market – debt, equity, or money market – can change every day depending on various factors.
A mutual fund is one of the widespread investment choices among people. An investor can invest in thousands of existing mutual funds in India. But choosing the top mutual funds or finding out which mutual fund is the best is not simple. Thus, if you are searching for the best mutual fund, you have to explore your risk profile and the time horizon of your objectives. The risk profile is your readiness and aptitude to take risks.
Therefore, a person eager to take more risks may invest in high-risk funds. But they will not be appropriate for an investor who can’t deal with risks. The time horizon of your objectives, i.e., the period during which one intends to have an investment for a particular aim, also plays an important factor. Investors can choose high-risk funds for their long-term objectives instead of short-term objectives.
What are the best mutual funds?
There are different types of mutual funds. We can separate mutual funds depending on their underlying assets like equity, debt, or gold into diverse categories, like equity mutual funds, debt mutual funds, and hybrid funds. These funds hold different risk profiles and investment goals.
Consequently, not one mutual fund is best for all. Your best mutual funds will be mutual funds appropriate for your investment goals, investment horizon, and risk tolerance.
The nature of risk differs from fund to fund, but the basic point is that mutual funds are not risk-free and you cannot expect assured returns. This is the major difference between mutual funds and fixed deposits. In finance, the most fundamental is the relationship between risk and return. You can expect higher returns only if you are ready to take more risks. So, it is very vital for investors to know how much risk they can take and build their investment decision on their risk ability.
Mutual funds are one of the most prevalent investment instruments. Experts called fund managers manage them. These experts put their effort into picking securities that can provide high returns. For investors who do not want to take the risks linked to investing directly in equities, mutual funds serve as alternatives.
The best mutual funds can be considered to be the ones that provide you with higher and more reliable returns on your investment.
Best Long Duration mutual funds
Long Duration mutual funds allude to funds that have outstanding potential and the aptitude to offer high returns. But these funds are extremely volatile in nature and are associated with high risks. When you choose such a Long Duration mutual fund, you will have to keenly and methodically review the performance of these funds periodically. This will allow you to know how your fund is performing in the market.
These Long Duration mutual funds usually give huge dividends to an investor. If you are ready to take a high risk in order to get good returns, then you can go for such a fund.
Different types of risk
There are 3 different types of risk in fixed-income investments –
- Interest Rate Risk: Interest rate risk is the understanding of the value of a fixed-income security to changes in interest rates.
- Credit Risk: Credit risk is the default risk of non-payment of interest and/or principal by the borrower. It should be noted that in fixed income, the investor is the lender, and the counterparty – bank, Government, bond issuer, etc. is the borrower.
- Reinvestment Risk: Reinvestment risk is the risk of the maturity profits of an investment being reinvested at a lesser rate of return i.e., interest rate than the initial investment.
We will examine how these risk types influence different investment products. Let us begin with a fixed deposit.
There is no interest rate risk for fixed deposits because the fixed deposit is a fixed maturity investment. The interest given by an FD is fixed for the FD term. Bank FDs have no credit risk.
Different mutual funds include different risk types. The SEBI (Securities and Exchange Board of India) comprises a labeling system (Risk-o-Meter) for categorizing the risk of different mutual fund products. The following are the different risk grades:
- Low Risk: These are the schemes of mutual funds with the lowest risk. They are suitable investment choices for investors seeking revenue and a low risk of capital loss. Different types of debt mutual funds fall in this risk grade
- Medium Risk: These are the schemes of mutual funds with moderate risk. These funds are more volatile and the capital loss risk in the short term is greater than low-risk funds. But these funds can offer better returns in the medium to long term compared to the low-risk funds and they are right for investors who are seeking revenue along with capital appreciation. Different types of hybrid mutual funds (both equity and debt), such as equity savings funds, monthly income plans, etc, are in this risk grade.
- High Risk: These funds are at high risk. The capital loss risk in the short term is highest in these funds. However, these funds can offer the maximum returns in the long term to investors seeking capital appreciation over a long investment horizon. Equity funds fall in this risk grade.
As fixed deposits are low-risk investments, the suitable mutual funds for making a comparison should be low-risk mutual funds, for example, debt funds.
What are debt funds?
The schemes of mutual funds investing in money markets or debt market securities are debt funds. Money market securities comprise certificates of deposits, commercial papers, treasury bills, etc. Debt market securities comprise Government bonds and corporate bonds (non-convertible debentures). Most debt funds are low-risk mutual funds, but you should keep in mind that they are not risk-free. But these funds can offer greater returns than Fixed Deposits over different investment tenures.