In the matter of wealth creation, investors often have to make a decision between mutual funds and other traditional forms of investment. Market experts explained the comparison between mutual funds and other traditional forms of investment, like fixed deposits (FDs) and Public Provident Funds (PPFs). They explained the importance of asset allocation for wealth creation.
Speaking with Zee Business, Akhil Chaturvedi, Director & Chief Business Officer, Motilal Oswal AMC, explained that over the last 20-25 years, mutual funds have become an important mode for wealth creation, providing investors with an opportunity to invest in different asset classes.
According to him, be it equity funds, debt funds, or hybrid funds, mutual funds have offered better returns to an investor compared to traditional methods of investing like fixed deposits, post office schemes, and provident funds.
“Mutual funds provide better diversification and a wider range of investment options. If you look at historical performance, they have significantly helped investors create wealth,” he said.
Comparison should focus on allocation, not competition
However, Rishikesh Palve, Director at Anand Rathi Wealth, emphasised that comparing mutual funds directly with FDs or PPF may not be entirely appropriate, as they serve different purposes.
He explained that mutual funds enable participation in both equity and debt markets, while instruments like PPF and FDs are primarily debt-oriented.
“Instead of comparing, investors should focus on building a balanced portfolio with a mix of equity and debt, depending on their goals and investment horizon,” he said.
According to him, for long-term goals of 15–25 years, investors can consider allocating around 80 per cent to equity and 20 per cent to debt.
Returns: Equity leads over the long term
Chaturvedi highlighted that returns from equity markets have historically been significantly higher than traditional instruments.
- Equity mutual funds: ~12 per cent long-term returns
- EPF: ~8 to 8.5 per cent
- PPF: ~7 per cent
- Fixed deposits: ~6 per cent
He added that the gap becomes even wider after adjusting for taxation and inflation.
“If you compare long-term returns, equity mutual funds can generate almost double the returns of fixed deposits,” he said.
Impact of inflation often ignored
Experts stressed that many investors focus only on nominal returns and ignore inflation, which erodes purchasing power over time. Chaturvedi pointed out that India’s long-term inflation typically ranges between 5–6 per cent, which significantly reduces real returns.
“In fixed deposits, post-tax returns often fail to beat inflation, resulting in negligible or even negative real returns,” he explained. In contrast, the performance of equity mutual funds, even if volatile, has the potential to deliver positive real returns in the long run due to the effect of compounding.
Tax efficiency and compounding advantage
Palve also pointed out the difference in the way interest income is taxed for both FD and debt mutual funds:
- FD interest is taxed annually as income
- Debt mutual funds are taxed at redemption under capital gains
This gives the advantage to the mutual funds to compound, as returns are reinvested without immediate tax outgo.
Liquidity vs Growth Trade-off
Experts agreed that traditional instruments still play an important role.
Chaturvedi suggested that investors should keep emergency funds equivalent to one year’s expenses in bank deposits or FDs for liquidity and capital protection.
“FDs are useful for safety and liquidity, but not ideal for long-term wealth creation,” he said.
Who should invest where?
Palve explained that the investment strategy should depend on the time horizon:
- Short-term (1–2 years): Prefer debt instruments
- Medium-term (5–10 years): Balanced allocation
- Long-term (15+ years): Higher allocation to equity
He added that a longer investment duration reduces risk in equities and enhances the benefits of compounding.
Where are investment opportunities now?
On current market opportunities, Chaturvedi said mid-cap and small-cap segments look attractive after recent corrections, especially for investors with a horizon of over 10 years.
Palve recommended a diversified approach within equity:
- 50–55 per cent in large-cap funds
- ~20 per cent in mid-cap funds
- Remaining in small-cap funds
Key takeaways for investors
Experts have also concluded that mutual funds, especially equity-oriented mutual funds, have a definite advantage over traditional investment options in the long-run wealth creation scenario. But instead of opting for one option over the other, a combination of both equity and debt mutual funds is considered to be the best option.