Investments are always compared by the person who has to find out which one will suit them best for them. The investment options most of the individuals come across include mutual funds, savings accounts, and fixed deposits. A common question in most people’s minds is why mutual funds do not provide fixed returns as savings accounts or FDs offer. So, this can be answered by first knowing the rudiments of these financial instruments and why they function in that way.
Nature of Mutual Funds Compared with Savings Accounts and FDs:
Savings Accounts and Fixed Deposits (FDs):
Savings accounts and fixed deposits have been a staple form of investment, belonging to the low-risk category. Their returns are generally fixed, making them stand out as a very stable source of predictable income for risk-averse investors.
Some savings accounts do provide the necessary liquidity but at very low returns, usually 3 to 4 percent a year, depending on the bank and the country. FDs provide returns at a rate of between 5 to 7 percent annually in India, and such returns are blocked for a set period, thereby remaining locked in for that period.
The main reason that these instruments can provide fixed returns is that they function on the basis of assured interest. Banks and financial institutions which offer savings accounts or FDs employ the deposited money to lend money or invest in low-risk, highly liquid assets such as government bonds or highly rated corporate debt and thus ensure the predictability of returns.
Mutual funds:
Mutual funds are fundamentally different from the two categories above. The money pool raised from investors is invested in a diversified portfolio of stocks, bonds, or other securities to create higher returns from capital appreciation and income. Since the value of the mutual fund’s portfolio will fluctuate depending on the performance of the underlying securities, the returns cannot be predicted to be fixed.
Why Don’t Mutual Funds Offer Fixed Returns?
Market Risk: The main reason that mutual funds have no fixed return is market risk. As contrasted with saving accounts or an FD, with a return provided by the latter based on its fixed interest, mutual funds will invest in assets whose value varies with market movement. Hence returns from such instruments are not always guaranteed; investments may even take a swing when their values will fluctuate sometimes.
Diversification: The mutual fund, in general, diversifies its investments across various assets. Thus, while the risk is spread out, it also means that the returns would depend on these assets’ performances. While it does help smoothen extreme fluctuations, diversification still doesn’t guarantee fixed returns because of the fluctuating market performance of the assets.
Potential for high returns: No fixed return is involved with mutual funds, but over the long run, they actually outperform long-term returns of traditional fixed-return alternatives such as savings or FDs. In fact, that is also true in the context of equity-based mutual funds. This is also particularly true for equity-based mutual funds because these have historically outperformed all other asset classes over the long run.
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Conclusion
Mutual funds are designed to provide flexibility, diversification, and the potential for higher returns, but this comes with the trade-off of not being able to offer fixed returns like savings accounts or FDs. While they may not provide the same level of security or predictability as these traditional investment options, mutual funds offer investors the opportunity to grow their wealth over time, especially when invested with a long-term horizon.
We, at VSRK Capital, understand that each investor has a different risk appetite and financial objectives. Our experts are here to guide you through the world of mutual funds and build a portfolio as per your requirements. Whether you are a conservative investor or one who is seeking higher returns, we can help you find the right investment opportunities.
FAQs
Why don’t mutual funds give fixed returns?
Mutual funds do not offer fixed returns because they invest in a diversified portfolio of assets, such as stocks and bonds, whose values fluctuate according to market conditions. This makes the returns unstable and unpredictable due to market volatility. Unlike fixed deposits or savings accounts, mutual funds are exposed to risk and potential for higher, but uncertain, returns.
What are the tax implications of mutual funds versus FDs?
Mutual funds get taxed on the capital gains front (LTCG or STCG), while FD interest gets taxed as per your income tax slab, and TDS gets applied on the interest amount when it exceeds ₹40,000.
Do mutual funds have lock-in periods like FDs?
Mutual funds generally do not have lock-in periods, but some schemes do, such as ELSS or Equity Linked Savings Schemes. They have a lock-in period of 3 years.