FD, FMP or debt fund: Which investment option aligns with your goals?

It can be challenging to navigate India’s fixed-income market. Three options that are often considered are fixed deposits, debt funds and fixed maturity plans.

Although each of these investment options provides relative stability of invested capital and the potential for steady returns, they differ in their structures, liquidity, and tax outcomes.

In this article we will understand these investment options in detail, understand the differences between them and see how they align with your financial aspirations.

• Table of contents

• Understanding the different investment choices
• What is a fixed deposit (FD)?
• What is fixed maturity plan (FMP)?
• Understanding debt funds
• How do they compare across key investment factors (FD vs FMP vs Debt Fund)?

Understanding the different investment choices

Many investors choose a mix of FD, FMP or debt fund instruments. For instance, some keep a portion in FDs for assured returns and capital preservation, allocate some to an FMP for relatively predictable return potential and lock-in discipline and place some portion in short-term debt fund for quick access of cash. Balancing these elements can enhance overall portfolio stability.

What is a fixed deposit (FD)?

For anyone asking, “What is fixed deposit?” the short answer is that it is a traditional instrument where you deposit a lumpsum with a bank or non-banking financial company for a set term. FDs guarantee a predetermined return since the Interest rate remains fixed. Some key features of fixed deposits include

• Security: In India, deposits up to Rs. 5 lakh per bank are insured.
• Predictable returns: Regardless of market shifts, your FD rate remains unchanged.
• Liquidity concerns: Premature withdrawal invites penalties, potentially lowering net returns.

FDs are popular because of their simplicity and reliability. Yet, during low-interest phases, your real gains might lag behind rising costs or more dynamic products.

Also Read: Overnight funds vs. short-term debt funds

What is fixed maturity plan (FMP)?

If you’re curious about the “fixed maturity plan meaning,” we can tell you that an FMP is a close-ended mutual fund scheme that invests in debt instruments and fixed income securities such as bonds, certificates of deposit, commercial papers, etc.

FMPs have a fixed maturity date, which means they lock in your money for a specified period of time, ranging from a few months to a few years.

• Close-ended structure: Units can be purchased from the Asset Management Company only during the New Fund Offer (NFO) and redeemed upon maturity. In the interim, they are listed on stock exchanges, and investors can purchase or sell units depending upon market value and demand/supply.
• Potential upside: FMPs can capitalise on specific market conditions, but returns aren’t guaranteed.
• Limited liquidity: Though listed on exchanges, trading volume is often low, so exiting before maturity might be difficult.

FMPs appeal to those seeking a targeted timeframe without major fluctuations, but they involve more uncertainty than FDs.

Understanding debt funds

When people wonder, “What is debt fund?” they’re generally referring to mutual funds focused on fixed-income securities like treasury bills, corporate bonds, and government securities. SEBI’s categorisation guidelines classify debt funds by duration and credit profile.

• Varied categories: Options range from liquid and overnight Funds offering insta-redemption to longer-duration funds. Each category suits different horizons and risk appetites.
• Market movement: The net asset value (NAV) can fluctuate as interest rates or credit conditions shift.
• Professional management: Skilled fund managers strive to optimise yields and mitigate risks.

Most debt funds are open-ended, so units can be purchased or redeemed at any time (standard redemption timelines apply). You can invest directly with the AMC or through distributors under a regular plan.

How do they compare across key investment factors (FD vs FMP vs Debt Fund)?

Return potential

• FDs: Offer guaranteed, moderate returns. No scope for higher gains if markets move favourably.
• FMPs: Returns can exceed FD rates when interest rates are favourable. However, returns are not fixed or guaranteed.
• Debt funds: Similar to FMPs, debt funds can offer better potential returns than savings accounts or FDs of similar tenures. Short-term debt funds typically have lower return potential than long-term ones. Here too, returns are not guaranteed and depend on market conditions.

Access to funds (Liquidity)

• FDs: You can withdraw prematurely by paying a penalty, but this reduces effective returns.
• FMPs: Usually locked in for the scheme’s term. Exchange listings rarely provide a viable exit.
• Debt funds: Are generally liquid, though a nominal exit load might apply in some schemes if units are redeemed before a certain minimum holding period (eg: one week, six months etc).

Also Read: Short duration vs. long duration debt funds

Taxation implications

• FDs: Interest is added to your income each year and taxed as per your prevailing tax bracket.
• FMPs and debt funds: Capital gains are taxed at redemption as per the prevailing income tax slab.

Return potential

• FDs: Offer complete rate certainty if held to maturity.
• FMPs: Designed to mitigate interest rate risk by matching instrument maturities, but market conditions can affect outcomes.
• Debt funds: Lower risk than equity funds, but NAV fluctuations can occur daily. Shorter-term funds are typically less volatile, while longer-term funds can see bigger price movements.

Conclusion

Choosing among FD, FMP, or debt fund is about balancing stability, liquidity, and potential returns while considering taxes and personal comfort with risk. By spreading your diversifying wisely and consulting experts, you can harness the distinct strengths of each product to potentially grow your money.

FAQs:

What is better than FD investment?

‘Better’ depends on your objectives. While FDs offer stability, FMPs or debt funds may generate better returns in favourable market conditions. Additionally, debt funds also offer liquidity, unlike FDs and FMPs, which are locked in until maturity. For some, diversification across various products can be more suitable than putting all funds in a single avenue.

Are debt funds better than FD?

Debt funds can offer better potential returns than FDs of the same tenure. For example, a money market fund with a maturity profile of roughly one year may offer comparable or better return potential than a one-year FD. Additionally, unlike FDs, debt funds offer liquidity. However, returns in debt funds are not guaranteed and can be lower if market conditions are unfavourable.

So, the more suitable choice for you depends upon your liquidity needs and how much risk you’re willing to accept.

Is debt fund good for a long term?

Debt funds are generally more suitable for short-to-medium term investments because their potential returns may not outpace inflation in the longer term. For long-term wealth building, equity funds offer better return potential, but with higher risk. However, conservative investors who do not want the volatility of equity investments may consider debt funds for longer durations.