By Selection among different investment options is very important in the path to financial goals. SIPs and FDs are the two most common choices among investors in India. Under their own special features, advantages, and disadvantages, they suit entirely different kinds of investor profiles that serve different financial objectives. In this post, we are going to compare SIP and FD in detail to derive which investment option works best for you.
Understand the Basics
FD: Fixed Deposit is an old investment tool that is offered to most-by banks, post offices, and NBFCs. In an FD, you deposit a lump sum amount in terms of years, days, or even months at a previously agreed-upon interest rate. The interest earned is mainly fixed for the tenure period providing a guaranteed return.
SIP: A SIP stands for a Systematic Investment Plan through which an individual invests in mutual funds. Instead of parking a huge sum all at once, an individual can channelize a specific amount at regular time intervals, mostly monthly or quarterly, into a selected mutual fund scheme. This method helps in rupee cost averaging as well as benefiting out of compounding over time.
Major Differences: The Comparative Analysis
Now, let us compare the SIP and FD on the various parameters to arrive at a well-informed decision regarding the same:
1. Nature of Investment:
FD: Includes a one-time investment by chunk amount.
SIP: Includes fixed investment amounts but on a periodic basis. Hence, it is open for investment even to those who do not have a large amount to put in at the same time, starting as little as ₹100 per month.
2. Returns and Risks:
FD: Both returns are fixed and guaranteed, with a predetermined interest rate. It usually comes under low-risk as returns are not influenced by market fluctuations. Compared to market-linked investments, returns earned are comparatively lower.
SIP: Invests into mutual fund schemes, which are market-linked. Hence, returns are not guaranteed but can fluctuate based on the performance of the underlying asset(s) (equity, debt, or a combination). However, SIPs, especially in equity mutual funds, have the potential to generate higher returns over a long investment period, thanks to rupee cost averaging and compounding effect.
3. Liquidity:
FD: Generally fixed for a period, and in the case of early withdrawal, penalty fees in the form of lesser interest come. Loans can be availed against these FDs, but they are less liquid compared to SIPs. Tax-saving FDs have a lock-in period of 5 years.
SIP: It grants higher liquidity, as you can typically redeem your mutual fund units anytime except sometimes some schemes may charge an exit load if redeemed before a specified time. Cash, normally, will be credited into your account within a few working days. It also allows the stopping or pausing of your SIP investing anytime.
4. Investment Horizon:
FD is suitable for short to medium-term investment goals where capital is protected and returns guaranteed.
Taxation :-
FD:– The interest that you have got on the fixed deposits becomes taxable as per your income tax slab. In addition, banks will deduct TDS as interest income exceeds the fixed limit (currently ₹40,000 per annum for non-senior citizens and ₹50,000 for senior citizens).
SIP: Returns from SIPs in mutual funds are considered capital gains and taxed accordingly. Equity funds have a short-term capital gain of 15% where the investment is held for less than 1 year. For a long term capital gain where the investment is held beyond 1 year, above ₹1 lakh in a financial year, is taxed at 10%. For debt-oriented funds, it has a different set of taxes for short-term and long-term capital gains and may have indexation benefits built in.
Flexibility :
FD: Limited flexibility after the investment has been made. The terms of tenure and interest are set.
SIP: Has much greater flexibility. You can start with a very small initial investment, make increases or decreases in your monthly investment, define how often you invest, or switch to another fund-scheme from the same fund house, with flexibility according to your changing needs and market conditions.
Effect of Inflation:
FD: There may be times when real returns from stabilized deposits will be low or even negative during a high inflation economy because these deposits are guaranteed nominal returns. Thus, the purchasing power of your returns is diminished.
SIP: Equity SIPs can beat inflation considerably in the long run as the returns are linked to the growth of the economy and corporate earning potential.
Market Fluctuations:
FD: Does not have market volatility because returns are fixed. Thus, it will always be a preferred choice among risk-averse individuals.
SIP: Gains from market conditions through rupee cost averaging. When the market is low, your fixed investment buys more units, and these units increase in value when the market recovers. This helps average out your purchase cost and reduces the market’s impact on your investment portfolio.
Advantages: Fixed Deposits
Safety and Assured Returns: FDs are one of the safest investment options, with guaranteed returns that lie beyond the reach of market risks.
Capital Preservation: They are very handy for those types of investors who prefer keeping their principal amount safe.
Option for Regular Income: Certain FDs offer a feature for the receipt of interest at regular intervals- monthly, quarterly, yearly- should one desire to receive a pay-out from his FD regularly.
Easy to Understand and Invest: Very simple to understand and the investment becomes pretty direct.
Loan Facility: Against your FD you can take loans also.
Disadvantages of Systematic Investment Plan
1. Market Risk: Returns are dependent on fluctuations in the market and negative returns are possible in the wake of poor performance by the market.
2. No Guaranteed Returns: Unlike deposits, there are no guarantees with SIPs.
3. Requires Long-Term View: To fully enjoy the benefits of SIPs, funds must remain invested for long-term.
4. Fund Selection: The suitable mutual fund scheme requires in-depth research and understanding of the market.
Which Way Should One Go?
SIP or FD would depend on your circumstances, financial goals, risk appetite, and investment horizon.
Go for FDs when:
You are a risk-averse investor looking for guaranteed returns and safety of your capital.
You have a lump-sum to invest.
Your horizon is short to medium-term.
You require steady income.
You prefer a low-maintenance investment option with clear terms.
Go for SIP if:
You have a long-term financial goal (like retirement, children’s education, buying an apartment, etc.)
You can accept a moderately high level of risk in exchange for higher returns.
You like to invest regularly in smaller amounts.
You want to benefit from rupee-cost averaging as well as the power of compounding.
You are quite comfortable with market-linked investments.
Think About a Combination:
Another option to consider is investing in both SIPs and FDs for good portfolio balance. This way, you can benefit from the safety and guaranteed returns of FDs, alongside benefiting from the growth potential of SIPs. The allocation would depend on individual characteristics with respect to risk and financial objectives.
Conclusion
Both SIPs and FDs are worthy investment tools in their respective rights. Gaining an understanding of their characteristics, benefits, and drawbacks becomes essential for informed investing. Reflect on your financial goals, risk appetite, and investment horizon in order to be clear on which option suits you best in your wealth-building journey, or which combination of both would be appropriate as a mix. Do not forget to review portfolios regularly and make changes from time to time in keeping with your changing financial requirements and overall economic conditions.