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Comparing Fixed Deposits and ETFs: An In-Depth Analysis for Investment

by tavaga

Fixed Deposits (FDs) meaning:

Fixed Deposits, or FDs, are investment instruments offered by banks for varied investment horizons. FDs provide a fixed rate of interest on investments and carry negligible investment risks. Due to low risks, the returns on FDs are also lower than other riskier investments like equities. FDs provide a fixed return, usually higher than the inflation rate. The rate of returns in fixed deposits also varies upon the period of your investments. The longer your investment horizon, the higher is the rate of interest.

Within fixed deposits, there are cumulative fixed deposits and Non-cumulative fixed deposits. Cumulative Fixed Deposits reinvest the interest earn on FDs, compounding the returns for investors. Noncumulative FDs on the other hand payout interest every year to the investor and there is no reinvestment.

Apart from FDs offered by banks, there are Corporate FDs as well offered by Non-Banking Financial Institutions (NBFCs). Since NBFCs are not as secure as banks, the corporate FDs provide higher rate of interest compared to mainstream banking institutes. Other factors of a corporate FD are same as a normal FD. Corporate FDs are offered by institutes like Bajaj Finserv, Mahindra Finance, Sriram Transport, or LIC housing finance. Corporate FDs are not covered by DICGC deposit insurance, while Bank FDs inherently fall under the insurance scheme.

ETFs meaning:

Exchange-traded funds, or ETFs, are a type of mutual fund that tracks the portfolio of an index. Since ETFs include all the stocks that are included in the index, the returns provided on the ETFs are the returns of the broad market index. Some examples of indices that ETFs track are Motilal Oswal NASDAQ 100 ETF that tracks the NASDAQ index, SBI Nifty 50 ETF that tracks the Nifty 0 index. Since ETFs hold a wide range of stocks, they are well-diversified and do not carry unsystematic risks.

There can be equity ETFs or debt ETFs. Debt ETFs follow a debt index or invest your money in fixed income security indices. ETFs can be traded on the stock exchange like normal shares and carry a small expense ratio as a management fee to maintain the passive portfolio. Know more about ETFs here!

Difference Between ETFs and Fixed Deposits

Risk, Predictability, and Safety

Fixed Deposits provide definite returns that are stated according to the period of investments. There is a minimal risk because banks can not run out of cash and hence the investment is secured. The value of your investment in FDs stays constant over time and the interest gets added on. Due to the low-risk profile of Fixed Deposits, the interest earned on FDs is also low. The value of the FD investment can be predicted accurately over the time horizon. FDs are safe investments for non-risky investors.

ETFs on the other hand, are stock market securities that carry inherent market-wide risk with them. The returns are not definite and can not be predicted over time. In case of adverse economic scenarios like Covid-19, stock market indices come significantly down, and so does the value of the ETFs that invest in them. In years of high growth and substantial gains in the stock markets, the ETFs provide much higher returns than savings accounts. Such scenarios are not possible with Fixed Deposits as their returns are fixed at the time of investment. ETFs are on the lower side of the risk spectrum in terms of equity securities, but if compared to FDs, ETFs carry higher risk.

Time Horizon, Liquidity and Flexibility

The time horizon for fixed deposits is decided at the time of investing. Investors get a fixed return over that period and it is usually not allowed to break your Fixed Deposit. FDs can be of maturities varying from 7 days to 10 years and more. Liquidity on fixed deposits is lower when compared to ETFs as funds can not be withdrawn on will. Fixed Deposits are also less flexible in terms of adding more investments. Every time you want to put more money into an FD, you will have to start an agreement with a prevalent interest rate in the economy.

Exchange-Traded Funds are just like stocks trading on the stock exchange. They can be bought and sold anytime through a Demat account or a broker. The holding period depends on the will of the investor. In terms of liquidity, ETFs are extremely liquid, investors can sell their ETFs like shares and get their money in their bank account whenever they want. In case of additional investment capital in hand, investors can purchase additional units of ETFs on the stock exchange at the market price any time they want. In terms of liquidity and flexibility, ETFs beat FDs.

Returns

Returns on fixed deposits are fixed throughout the lifetime of the investment. Although, the FD interest rates offered by banks keep changing with time. In India, FD interest rates are linked to the repo rate and move closely with it. Interest rates on FDs also vary on the time horizon of investment. A longer time horizon means a higher interest rate since your money is locked in for a longer period. Senior citizens in India also get higher interest rates on FDs of the same maturity as compared to the younger counterparts.

Returns on ETFs are linked to the index they track. ETFs provide higher returns than FDs because of the higher market risk they bear. The returns are highly dependant on market conditions and how the underlying securities in the index perform as well as the economic scenario of the country. Some of the ETF’s v/s Mutual Funds are listed in the table below:

Taxation and Expenses

Interest income on Fixed Deposits is taxable as per the Indian income tax laws. The tax slab on the interest received on FDs is the same as the total income tax slab for an individual. But interests on FDs are only taxable if the interest earned is more than Rs. 40,000 for a general citizen, or more than Rs. 50,000 for a senior citizen. An individual will total income of less than Rs. 2,50,000 are exempt from paying taxes. Apart from the income tax, there are no other charges and expenses.

Returns from ETFs are also taxed according to the capital gains tax in India. Apart from that, ETFs also incur an expense ratio which the manager’s fee for investing and maintaining the portfolio of securities. The expense ratio for various ETFs range around 0.5 per cent of the total investment value and is deducted over the year from your Net Asset Value (NAV). ETFs also carry the brokerage fee and transaction charges as specified by SEBI. You can read more about the costs and commissions of ETFs here.

How to Invest

To invest in a fixed deposit, you need to have a savings account with the bank you want to have an FD with. You need to then deposit the amount at the specified interest rate offered by the bank as per the investment horizon. Nowadays, FDs can be made through net banking or mobile banking accounts as well.

To invest in ETFs, you need to have a Demat account with a broker of your choice. Once your Demat account is ready, you need to add funds to the account and then ETFs can be traded just like shares on a stock exchange.  

Conclusion

ETFs and Fixed Deposit are both investment instruments, but they suit the need of different investors. While FDs are better suited to risk-averse investors who want to preserve their capital and are happy with smaller returns, ETFs are a great investment for individuals who are ready to bear the market risks and expect higher returns over time.

 While ETFs are a better tool for risk seekers, FDs also play a major role in risk-seeking portfolios as it provides stable returns, unlike any other investment product. Hence, optimal asset allocation is the key to every portfolio, and Tavaga, as a SEBI Registered Investment Adviser can help you achieve an appropriate asset allocation. One should always analyze his risk-taking capacity as well as his liquidity and return requirement before investing in any instrument. Happy Investing!

Disclaimer: This write up is solely for educational purposes. This in no way should be construed as a buy/sell recommendation. Please consult your investment advisor before investing.

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