Careful investment planning is the basis of your financial success, and a large part is portfolio diversification. Investment portfolio diversification is a strategy to distribute your investment corpus across different asset classes to minimise risk and maximise returns. A potent example of this is to include Mutual Funds (MFs) and Fixed Deposits (FDs) in your portfolio, as both play different roles in helping you reach your financial goals.
To understand more about why you should include both these investment options in your portfolio, you need to understand the concepts in detail. So, read on to learn more about fixed deposits and mutual funds.
FDs vs MFs: A comparative analysis
FDs and MFs represent two different investment options in terms of investment principle, return, tenure, liquidity, etc. So let’s analyse each financial product to see its benefits and shortcomings more closely.
FDs are one of the safest investment options in the market. You invest a certain amount at a fixed interest rate for a particular period. And, once the deposit matures, you get the return at the pre-set interest rate. The real charm of FD is that it is not affected by market movements, so your returns are guaranteed.
Benefits of investing in an FD
- The guaranteed return is the biggest benefit of FD. Your return is assured regardless of the market condition
- The interest rate does not change with time; you earn the rate decided before your investment. So, you already know the amount you will earn. As a result, you can plan your finances better
- FDs offer great liquidity, as you can break the deposit before maturity by paying a small fee. However, this facility is not available for tax-saving FDs, so keep that in mind.
- On the other hand, if you don’t want to break your deposit, you can mortgage it to get a loan against it. You can get up to 90% of the deposit’s value as a loan. Also, while servicing the loan, you keep earning interest on the deposit. Therefore, with this facility, you can quickly meet your financial requirements without liquidating your investment
- FDs have multiple interest payout options. Here, you can choose from cumulative and non-cumulative options. With the cumulative option, you earn the total interest after maturity. But, with non-cumulative, you can take out the interest monthly, quarterly, half-yearly, or annually
Drawbacks of an FD
- The return on FDs is lower when compared with options like MFs and stock market investments
- This is a one-time investment, so you cannot change the amount once you invest in the deposit
- When you withdraw the FD before maturity, you may have to pay a penalty charge
MFs are a more dynamic investment option where a financial institution organises a group of stocks and then invests in them from the sum you invest in them. Let’s simplify this with an example.
For instance, Fund house A has introduced an IT mutual fund, which only consists of stocks from IT companies. So, when you invest in this fund, your sum is distributed among all the funds, and you get a return based on how all these companies perform in the market.
Benefits of MFs
- MFs offer great returns when you properly choose the right fund and time your investment.
- MFs offer you two ways to invest, you can either opt for the lump-sum option, or you can opt for a Systematic Investment Plan (SIP). With SIP, you can invest in smaller amounts, and hence, it offers better accessibility
- MFs are highly liquid, so you can sell your investments easily. Moreover, you have the option to sell even a smaller portion to meet your requirements.
- Professional fund managers manage MFs, and they optimise your investment so that you get the best return.
Drawbacks of MFs
- The most significant disadvantage of MFs is the risk it entails. Since it is directly related to the market, your returns will be affected by factors affecting the market
- When your investment matures, you may have to pay a specific commission to liquidate it. However, if you invest directly, you can avoid this problem. Nevertheless, this additional charge increases the cost of your investment
- You do not know how much you can earn with MFs, so making financial plans based on it can be difficult
Therefore, FDs are a low-risk investment option and best suitable for those who want assured returns on their investment. Whereas MFs are more dynamic, and if you are willing to take risks, it can bring great results.
Why should you have FD and mutual funds in an investment portfolio?
The primary reason for including these financial products in your portfolio is to bring the required balance. To explain, while the FD will bring the much-needed stability and guarantee of return, the MF will bring additional income through a higher Return on Investment (ROI).
Furthermore, since both investment options are available for a longer term, at least 5 years or more, you can easily plan your finances based on the earnings you can generate. Let’s say you plan to purchase a house after 4 years and want Rs 10 lakh for a down payment. In this case, you can diversify your investment to get to this amount even in the worst of market conditions.
Also, with a longer investment horizon, you can easily make up losses in an MF and get great returns. And, when you couple it with an FD booked at a handsome return, you are looking at a substantial corpus.
Also, the high-liquidity element ensures you can get out of it anytime and meet your urgent financial needs.
In summary, having FDs and mutual funds in a portfolio is a great way to plan your finances. This way, you can extract the benefits of both these investment options and get the best possible return.