Mutual Fund Vs Fixed Deposit: What makes MFs different from FDs? Does volatility only pose risks or provide opportunities?
Fixed deposit (FD) is the most popular mode of investment in India because it is a simple product and is also easy to operate. On the other hand, investing in a mutual fund (MF) needs knowledge of the product, market risks as well as goal-based investments and even a demat account to make the operations easy.
It’s not only about complexity, but the main difference is that investors get interest on the FD amount at a pre-determined rate, which remains fixed during the investment period, while MFs are capital assets like gold, value of which itself fluctuates to provide investors capital gains or losses.
While the capital doesn’t fluctuate in case of FDs and all the investors, who invest at a given interest rate for a specific period, get equivalent return depending on amounts invested and investment period, but the fluctuations in equity markets provide investors opportunity to get different returns, which though poses risks in the short term, but provides greater return in the long run over the fixed-return investments.
So, the market volatility makes equity exciting and rewarding as compared to a bank FD, which provides equity MFs the potential to deliver superior returns in the long run.
Volatility is the basic nature of equities that carries a risk which is not there in guaranteed investments. So, investors need to be mentally and financially prepared to take hits on their portfolios and digest even negative returns in short to medium term.
Volatility is inherent in the stock markets that creates opportunities for investors to enter the markets. Without volatility, all the stocks will be fully valued to their (earnings) growth expectations at all times and in such a hypothetic and predictable market, everyone will invest in stocks and the advantage of equities over debt investments will no longer exist.
In such a case, like fixed-return investments, investors would only gain over others by investing a higher amount for a longer duration.
It is only volatility that gives opportunities to investors and fund managers to identify opportunities in the market to deliver higher returns for investors. Such higher returns over and above market / benchmark returns are called Alpha returns and are generated due to fund management expertise.
So, volatility not only provides opportunity to generate higher returns in the long run over fixed-income investments, but also gives a chance to earn differential returns among equity investors as well.