Should you invest in Fixed Deposits (FDs) or Mutual Funds?

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Unfortunately it’s taken me nearly 15 years to realize that investing in Bank or Company fixed deposits (FDs) is a terrible investment choice. If you have a long term horizon you should definitely choose investing in Equity Mutual Funds via SIPs or Lumpsum.

The BSE Sensex has given an average year on year return of approx 16% over a 38 year period. The same is true even if you exited in 2008 (which was a terrible year for the stock market).  Now let’s assume you manage to get a FD interest rate of 8%. This assumed interest rate of 8% is higher than any current bank FD rate at the time of publishing this post.  In order to truly understand the real cost of investing in FDs let’s assume you invest 5 lakhs in a Bank FD and another 5 lakhs in a BSE Sensex Index Fund. Lets see what you could get if you withdraw after 40 years.

5 Lakhs deposited in a bank FD at 8% compounding (0% tax)

Now lets say you deposit you 5 lakhs in a Bank FD which promises you a 8% interest rate
YearsInterest RateTax RateAmountAmount in words (Rounded)
080%5,00,0005 Lakhs
580%7,34,6647 Lakhs
1080%10,79,46211 Lakhs
2080%23,30,47823 Lakhs
3080%50,31,32850 Lakhs
4080%1,08,62,2601 Crore 9 lakhs

 

5 Lakhs deposited in a bank FD at 8% compounding (20% tax)

Now lets say you deposit you 5 lakhs in a Bank FD which promises you a 8% interest rate
YearsInterest RateTax RateAmountAmount in words (Rounded)
0820%5,00,0005 Lakhs
5820%6,80,3787 Lakhs
10820%925,830 9 Lakhs
20820%17,14,32217 Lakhs
30820%31,74,34332 Lakhs
40820%58,77,80658 Lakhs

 

5 Lakhs deposited in a bank FD at 8% compounding (30% tax)

Now lets say you deposit you 5 lakhs in a Bank FD which promises you a 8% interest rate. The Income tax rate assumed here is 30%
YearsInterest RateTax RateAmountAmount in words (Rounded)
08305,00,0005 Lakhs
58306,54,735 7 Lakhs
108308,57,3559 Lakhs
2083014,70,11815 Lakhs
3083025,20,82925 Lakhs
4083043,22,49743 Lakhs

 

5 Lakhs at 16% Compounding - 10% Long Term Tax

The BSE Sensex has managed to give a 16% CAGR over the last 38 years
YearsInterest RateLong Term Capital Gains TaxAmountAmount in words (Rounded)
01605,00,0005 Lakhs
516010,50,17010 Lakhs
1016022,05,71722 Lakhs
20160 97,30,37997 Lakhs
301604,29,24,9384 Crores 29 Lakhs
40161017,04,24,52117 Crores (After Tax)

 

So you can see that if you fall in the 20% Tax slab you would make 58 Lakhs after 40 years of investing in a Bank FDs instead of making 17 Crores with the BSE Sensex. Is the difference of 16.5 Crores worth that false sense of mental safety that you get with a FD? I personally have stopped investing money in FDs and focus more on equity returns keeping a 20 year horizon in mind. I would not recommend you invest your money in equity mutual funds if you have a short term 1-3 years horizon in mind. I would also not recommend Equity mutual funds if you are trying to save the money for a House, marriage, education etc.

One thought on “Should you invest in Fixed Deposits (FDs) or Mutual Funds?

  1. well thanks your article of index funds is outstanding.kindly guide who had started late but now like to invest for 5 years with risk.thanks .regards

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