Mutual Fund Returns: Mutual Funds or FDs: Which is Better for a Ten Year Investment?
When you invest in a FD, banks lend money to businesses in the form of a loan. And when you invest in equity mutual funds, the asset management company (AMC) additionally invests the accumulated funds on the stock exchange to buy stocks. Regardless of how you invest, ultimately money is invested in businesses and your funds are associated with credit risk.
On the one hand, when people invest in an FD bank, they feel relaxed. They don’t have to worry about the risks associated with investing. However, on the other hand, when they invest in mutual funds (MFs), they feel that their money is at risk.
The point is, whether it is FD or MF, the money is loaned to others, and there is always a risk associated with it. If you compare the returns of large-cap equity mutual funds with those of bank FDs, the difference is huge. Therefore, we need to understand in more detail the risk associated with the investment instrument.
Why term deposits?
First, let’s understand how FDs are safer than mutual funds:
- Portfolio diversification: Banks have diversified portfolios because they lend not only to businesses but also to individuals. Banks have several forms of loans to attract as many customers as possible, such as personal loans, home loans, two or four wheel loans, etc. While equity mutual funds typically invest in the top 25 to 100 companies. On the other hand, banks have millions of customers under their authority.
- Insurance on FD: Each FD is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which is a wholly owned subsidiary of the Reserve Bank of India (RBI). However, this insurance covers a maximum amount of Rs 5 lakh. This means that in the event of a bank default, the DICGC is required to pay you the amount FD (only up to Rs 5 lakh).
- Returns are guaranteed: There are no market risks associated with FDs. Therefore, the returns are guaranteed by the banks.
Risk in mutual funds
Credit risk: If you invest in large cap mutual funds, these funds invest the accumulated amount in the top 20 to 50 listed companies in India. To understand the true value of these companies, let’s understand the concept with an example of Nifty50, which represents the top 50 companies in the Indian stock market.
The market capitalization (capitalization) of these 50 largest companies is Rs 113.5 lakh crore, which is almost 60% of India’s gross domestic product (GDP). These companies come from 14 different industries such as Automotive, Pharmaceuticals, Banking, etc., and they are the top companies in their respective industries. In fact, the Indian economy is very dependent on these companies, so it is practically impossible for all of these companies to default at the same time and your investment to go down the drain.
Market risk: As you may have heard on a daily basis, mutual funds are subject to market risk. In fact, they are. However, if you stay invested for at least ten years, Nifty 50, a benchmark of stock market performance, has never given negative returns.
Over the past 20 years, it has yielded an average compound annual growth rate (CAGR) of 12.3% and a minimum CAGR of 5.5% (near current FD rates) over a ten-year investment horizon. Therefore, if you are investing for the long term, you can rely on the stock market.
Let’s say if you invest Rs 1 lakh for ten years, an FD will pay you Rs 1.79 lakh (assuming a return of 6%). However, if you invest the same amount in large cap mutual funds, it will become Rs 3.40 lakh (assuming a 13% return, which is the average of all large cap mutual funds. in 5 years). This represents nearly 190 percent of FD returns.
In conclusion, you need to make an investment decision keeping in mind all of the factors mentioned above because investing in an FD is secure compared to mutual funds, but the cost of that security is huge. and the yields are extremely low.
(Ravi Singhal is Vice Chairman of GCL Securities Limited)