RDs and debt funds are two types of investments that can help you save and build wealth over time. Recurring deposits are secured term deposit accounts where you deposit a fixed sum monthly that earns a fixed interest for a definite period. Debt funds, on the other hand, are mutual funds that invest in different debt securities and carry market-linked risk. While debt funds carry a higher risk than RDs, they also offer better returns. Apart from this, RDs and debt funds also differ in terms of returns, liquidity, and taxation.
Understanding the RD vs. debt fund debate is crucial for investors to map out a strategic investment portfolio. In this article, we will clarify the differences between RDs and debt funds, their meanings, and risks.
Understanding debt fund
Debt funds are mutual fund schemes that pool money from different investors to invest in debt securities like government bonds, debentures, treasury bills, corporate bonds, and other money market instruments. Since debt funds invest in fixed-income securities, they are less volatile than equity funds. Returns from debt mutual funds are generated through interest income and capital appreciation. Investing in mutual funds with underlying debt securities is perfect for low-risk investors seeking relatively stable and predictable income along with capital preservation benefits.
Understanding recurring deposit
A recurring deposit is a term deposit account that allows investors to make regular contributions and earn interest. Regular contributions help cultivate a savings habit while ensuring flexibility to make monthly investments rather than a one-time lump-sum investment. Your contributions keep earning interest at a fixed rate until the maturity date. Once the RD tenure ends, the principal plus interest is credited to your savings account.
RD vs. Debt funds: A tabular comparison
Understanding the differences between RDs and debt funds is crucial for making informed financial decisions. The following table sums up the RD vs. debt funds debate in detail:
| Parameters | Recurring deposit | Debt funds |
| Investment type | RDs are term deposits where those with a regular flow of income can deposit a fixed sum monthly for a pre-given period of time. | Debt funds are a specific type of MF that invest in fixed-income securities like bonds, debentures, CDs, treasury bills, etc. |
| Investment amount | Monthly contribution to an RD is fixed. | Contributions to debt funds can be flexible depending on the financial capacity and goals of the investor. |
| Returns | Returns are based on fixed and predetermined interest rates. | Market-linked returns are based on interest rate fluctuations and credit quality of the underlying assets. |
| Liquidity | Premature withdrawals from RDs are permissible but attract a fixed interest rate penalty. | Debt fund investments are more liquid than RDs since you can redeem your units at any time. |
| Taxation | Interest earned is taxed as per the investor’s applicable income tax slab. | Interest earned is taxed as per the investor’s applicable income tax slab if fund units are bought on or after 1st April 2023. For units bought earlier and held for 3 years, a 20% LTCG tax is applicable with indexation benefits. |
Risks of investing in debt funds
Now that you know the differences between RDs and debt funds, it's time to understand the risks associated with each type of investment. Here’s a quick overview of the risks associated with debt fund investments:
Low returns
Debt funds tend to provide lower returns than other investment options like equities. The average annual return rate for debt funds varies from 5%-9%, which is lower than equity funds. Given this relatively low rate of return, you may have to wait for longer to see your investment grow and compound.
Not fully safe
While debt funds are safer than other types of mutual funds, they are not completely risk-free. Therefore, debt funds do not guarantee returns. Interest rate fluctuations can affect bond prices, in turn affecting your overall returns. Similarly, credit risks can result in defaults if the fund invests in assets with a poor credit rating.
Not for the long term
Debt funds may be apt for investors looking to earn returns over a short-term duration. The low returns of these funds make an imprudent choice for long-term investment goals. If you have long-term goals, investing a part in equity funds can help boost returns over the extended time horizon.
Risks of investing in a recurring deposit
Unlike debt funds, RDs are not market-linked and, therefore, ensure guaranteed returns. That said, RDs do come with the following set of risks:
Cannot withdraw the money anytime you wish
One of the chief disadvantages of an RD is the mandatory lock-in period. Once you start an RD, you cannot withdraw your investment until the end of the investment tenure. Most banks and NBFCs levy penal interests on premature withdrawals, eating away into your earnings.
Amount decided to invest monthly cannot be changed
When you open an RD, you are committing to deposit a fixed amount of money every month. In other words, you cannot change the amount of money you deposit monthly after the account has been opened. This lack of adaptability can be restrictive to investors since they cannot modify their savings and investment strategies with changes in their financial circumstances.
Comparatively lower rate of interest
RDs also have a lower rate of interest compared to other investment options like debt mutual funds. RD interest rates are fixed by the banks and financial institutions that offer RD accounts. These rates rarely beat the rate of inflation, resulting in the loss of your investment’s purchasing power. Additionally, parking funds in an RD can also be an opportunity cost for the investor since the same funds could be used to earn better returns if they were invested in debt or equity funds.
Why choose debt funds?
From the above discussion on RDs vs. debt funds, it is clear why investors prefer debt funds. These funds act as a stable hedge for your investment portfolio. While equity funds are great for long-term wealth creation, debt funds help manage short-term volatility with a consistent income stream. Debt funds are especially favourable for investors seeking a stable income source like retirees. The stability of debt funds cushions investors from intense market volatility while still providing them with the possibility to build a corpus over time.
Why choose RDs?
In India, RDs have remained a traditional investment vehicle trusted by millions. Although RDs do not yield inflation-beating returns, they do offer capital preservation. RDs are a preferred choice among small investors who find it difficult to invest with a lump-sum amount. For people with a tight budget and even tighter savings, RDs offer the perfect savings solution. Most financial institutions allow you to open RD accounts with a nominal sum of Rs. 500, helping you cultivate a consistent and disciplined savings habit.
Conclusion
In summation, it is important to note that both RDs and debt funds have their pros and cons. While RDs can help you develop a consistent savings habit with your monthly leftovers, debt funds can help grow your corpus with inflation-beating returns and meet various life goals. But remember that choosing between RDs and debt funds is not the primary objective. Understanding the RD vs. debt funds debate outlined above can help you devise a financial plan that lets you leverage the benefits of both and offset the risks involved in each.
If, like most Indians, you already have an RD account, you may want to diversify your investments with debt funds. To do so, you can rely on the Bajaj Finserv Mutual Fund Platform, where you can compare mutual fund schemes, estimate returns, and start SIPs - all in a jiffy. You can use free tools like the mutual fund calculator to calculate your returns and maturity corpus before investing to understand how to curate a balanced financial plan and portfolio.
