Investments can be explained as the act of allocating funds into an investment plan or depositing a part of your income into a bank account. While some invest in the market by opting to invest in some investment plans, a lot of Indians to this day look at a bank account, especially a fixed deposit (FD) as a viable investment option. But what if there was some other way to earn extra income and thereby acquire enough wealth at the time of retirement? That’s where debt funds, a subcategory of mutual funds step in. Please read below to learn what a debt fund and FD is and how they differ from each other.
Debt funds are the funds that are known for primarily investing in debt and money market instruments. They include things like certificates of deposits (CDs), Treasury bills (T-Bills), and commercial papers (CPs). Government Bonds and NCDs i.e., non-convertible debentures are prominent examples of debt market instruments. They are an ideal investment choice if your financial goal is to acquire a steady income in the future.
How does it work?
The fund manager invests in things like debt or money market instruments with only one aim. It is to enjoy revenue in form of interest payments. Unlike an equity fund, debt funds are known for having considerably lesser risks and that’s what attracts investors to them. Moreover, there are some types of debt funds that can help you to invest even for one day or several years. For instance, overnight funds are funds that are known for investing in instruments that mature overnight. Other than overnight funds, liquid funds are known for allocating funds in securities that reach maturity in less than 91 days.
What are its features?
- They can help in earning a stable income:
These funds are known for creating returns for the investor with the help of the maturity value and interest income from the underlying fixed-income securities. The interest rate and maturity value are fixed and thus, debt funds generate a stable and regular stream of cash flow that is not impacted by the risk of market fluctuations.
- They are liquid:
This type of mutual fund is known for allowing you to redeem your units on any business day. This is not possible in the case of an FD investment. FDs are known for coming with a specified maturity date. In case you opt to liquidate your FD prematurely, you will be charged a 1% penalty by the financial institution.
- These funds come with low investment risks:
As stated earlier, the fluctuations in the market don’t have a direct impact on debt funds. Things like the economy’s interest rate regime and its movements have an impact on debt funds. But the movements in interest rate are not drastic like say, share market movements. Furthermore, debt funds are known for investing in fixed-income securities that come with an already known maturity value and interest rate. Hence, these funds are known for having lower risks in contrast to equity funds.
Fixed deposit (FD):
Offred by either a bank or non-banking financial company (NBFC), FD is popular with people for providing an investor or an account holder until its maturity, a rate of interest that exceeds that offered by a regular savings account. Also, opening an FD may or may not involve creating a separate account.
How does an FD work?
By opting to invest your money in FDs, you deposit your money in a financial institution for a fixed period. In an FD, the investor can either enjoy interest on the principal sum during the tenure or on a cumulative basis. The interest earned by the investor is added to the principal amount after intervals.
What are its features?
Listed below are some of the salient features of an FD:
- They are considered a stable investment option:
Mutual funds, which are regarded as market-led investments are susceptible to changes as time passes. On the other hand, fixed deposits as an investment option are regarded as more reliable and secure. The reason why FDs are considered secure is that the returns generated by FDs are already fixed. Market volatilities don’t have an impact on them which makes the investment amount remain static during the investment tenure.
- FDs come with flexible tenures and can be renewed easily:
Another major feature is that you can hold on to your FD for a tenure that spans decades. You can choose your preferred tenure while opening the FD. Apart from selecting your preferred tenure, you can also conveniently renew the FD upon maturity. However, if you are opting to renew it upon maturity, please make sure to check the interest rates, as they may change.
Apart from the two above, it is also possible for an FD holder to avail of a top-up loan against their fixed deposits in case of need.
Are Debt funds and FDs similar?
Once you have decided to deposit your money in an FD, the financial institution (either bank or an NBFC) makes a promise to pay fixed interest in return. By opening an FD, you’ve lent money to the financial institution, and the said institution is the borrower of your money. Similarly, debt mutual funds are known for allocating funds to securities like company bonds, Money market securities, and government bonds. The said bonds are generally issued by entities like banks, power companies, and even the government. Bonds are issued with a promise of paying back their investors.
However, one of the aspects they differ in is the process of diversification. The said process is applicable only for debt funds and not FDs. Diversification is a technique in which the fund manager opts to spread the investments throughout different sectors. This action helps in mitigating risks.