Fixed deposits and SIP: How are they different and which one is better for you?

Fixed Deposits (FDs) have for long been a trusted investment option in India. In recent years, Systematic Investment Plans (SIPs) in mutual funds have gained popularity because of their potential for long-term wealth generation through disciplined investing.

Both investments have key differences. Knowing these can help you determine which investment avenue to choose between them or how to include both in your portfolio. This article tells you more about FDs vs SIP.

• Table of contents

1. What is an FD Investment?
2. What is an SIP investment?
3. Key differences between FDs and SIPs
4. FD vs. SIP: Which is right for you?

What is an FD Investment?

Investing in an FD involves depositing a fixed sum for a certain period at a predetermined interest rate. At the end of the tenure, you receive the principal amount and the interest. This financial instrument is offered by banks and non-banking financial companies (NBFCs). The biggest advantage of FDs is their safety. Your capital is protected, and returns are fixed and guaranteed.

What is an SIP investment?

An SIP is a route to invest in mutual funds. It involves investing a fixed amount at regular intervals – weekly, monthly, quarterly, etc. The investment portfolio may comprise equity assets, fixed-income assets, or a combination of both. Over time, small but regular investments have the potential to build wealth. Returns, however, are not guaranteed and depend on market conditions.

Key differences between FDs and SIPs

1. Liquidity: SIPs offer high liquidity, whereas FDs are locked in for the investment tenure. Premature withdrawal from FDs can result in penalties and reduced interest earnings. In comparison, you can redeem your SIP investments partially or completely at any time in most open-ended mutual fund schemes. You may have to pay a small exit load if you withdraw before a specified period (ranging from a week to a year). However, not all schemes have exit loads, especially those tailored for short-term investing.
2. Taxation: FD interest is taxable as per your income tax slab. The tax implications of SIPs depend on the type of mutual fund and the holding period. For debt mutual funds, the capital gains on the investments are taxed as per your tax slab. For equity mutual funds, capital gains on investments held for less than a year are taxed at 15%. The capital gains tax for investments held for more than a year is 10%. Equity-Linked Savings Schemes or ELSS mutual funds offer tax benefits under Section 80C of the old regime of the Income Tax Act, 1961. These funds, however, have a three-year lock-in period.
3. Flexibility: FDs do not typically offer partial withdrawal options. Moreover, if you have extra funds – such as after a performance bonus – you cannot top up an existing FD. You need to create a new one at the prevailing interest rate. SIPs offer greater flexibility as you can start, stop, increase, or decrease your investment amount at your convenience through a quick and simple process. You can also withdraw as many or as few units as you need.
4. Earnings: FD interest rates are fixed at the time of investment, offering a predetermined return throughout the tenure. SIP returns are not fixed and are subject to market fluctuations.
5. Tenure: FDs offer fixed tenures, ranging from a few months to several years. SIPs do not have a fixed tenure and can be continued for as long as you need, as per your investment goals.

FD vs. SIP: Which is right for you?

The right scheme for you will depend on several factors, which include:

1. How you want to invest: SIP investments are suitable for those who may not have a lumpsum at their disposal or would prefer to invest in regular instalments. FDs are suitable if you have a substantial sum that you want to set aside for a fixed period.
2. Risk tolerance: FDs may be suitable for risk-averse investors prioritising capital protection. SIPs typically have higher growth potential in the long term but are also subject to market volatility. Returns and capital protection are not guaranteed.
3. Liquidity requirements: If you want access to your funds, FDs may not be ideal due to lock-in periods.
4. Tax planning: Consider tax benefits. SIPs in ELSS funds can be beneficial for tax optimization.

Conclusion

Choosing between FDs and SIPs requires careful consideration of your financial goals, risk appetite, and investment horizon. FDs offer stability and capital preservation. SIPs provide the potential for wealth creation over the long term. By understanding the differences between FD vs SIP and the pros and cons of both investment avenues, you can make an informed decision.

FAQs

What is the minimum investment amount for FD and SIP?
The minimum investment amounts for FDs vary depending on the bank or NBFC. Some may have a minimum threshold Rs. 1,000. However, an FD is a one-time investment, so it is typically better suited to larger amounts. SIPs, on the other hand, typically start at Rs. 100 to Rs. 500 (depending on the mutual fund house and the scheme) and allow recurring investments.

What is the tenure for FD and SIP?
FDs offer a wide range of tenures, typically ranging from a few months to several years. For SIPs, you may choose an end date of your choice for your investments or continue investing for as long as your financial goals require. You can also pause or stop your SIP contributions if needed.

Can I withdraw my investment before maturity in FD and SIP?
Withdrawing an FD before maturity is possible but you may incur a penalty and lose out on the interest amount for the rest of the tenure. You can typically redeem your mutual fund units from your SIP at any time, although some funds might have exit loads applicable within specific holding periods.

Are FD and SIP safe investment options?
FDs, especially in reputable banks, are considered very safe as returns are fixed. SIPs invest in mutual funds, which are subject to market fluctuations. This means your investment value can go up or down.

How are returns calculated for FD and SIP?
FDs earn returns in the form of interest and the rate is fixed at the time of investment. Returns on SIPs come from the underlying assets. These could be in the form of interest payments for fixed-income assets or an increase in the value of equities in a portfolio. However, these returns are not fixed and depend on the performance of the underlying assets.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.