Mutual Fund vs Fixed Deposit – Which is Better for Passive Income?

Introduction

Building passive income is one of the smartest ways to achieve financial independence. In India, two of the most popular instruments used by investors for this purpose are Mutual Funds and Fixed Deposits (FDs). But which of these offers better returns, flexibility, and stability for long-term passive income?

Both investment tools have unique characteristics, benefits, and limitations. Understanding how they work and how they compare will help you make informed decisions suited to your income goals and risk appetite.

What is a Fixed Deposit (FD)?

A Fixed Deposit is a financial instrument where you deposit a lump sum amount with a bank or NBFC for a specific period, earning a fixed interest. FDs are known for their safety and guaranteed returns, making them a favorite for conservative investors and retirees.

Key Features of FDs:

• Assured returns with fixed interest rates
• Low to zero risk of capital loss
• Short to long-term options (7 days to 10 years)
• Premature withdrawal possible (with penalty)
• Interest payout options – monthly, quarterly, or at maturity

Interest rates currently range between 6% and 7.5% depending on tenure and the bank. Senior citizens often receive slightly higher rates (by 0.25% to 0.75%).

What is a Mutual Fund?

Mutual Funds are investment vehicles that pool money from various investors and invest in diversified assets like equities, bonds, or a mix of both. Fund managers handle the investments professionally to maximize returns.

Unlike FDs, mutual fund returns are not guaranteed — they depend on market performance. However, they offer the potential for significantly higher returns, especially over the long term.

Types of Mutual Funds Suitable for Passive Income:

• Equity Mutual Funds – Invest primarily in stocks; ideal for long-term growth
• Debt Mutual Funds – Invest in government bonds, corporate debt; lower risk
• Hybrid Funds – Combine both equity and debt for a balanced approach
• Monthly Income Plans (MIPs) – Debt-heavy hybrid funds designed to generate regular income

You can use a Systematic Withdrawal Plan (SWP) to generate a monthly passive income from your mutual fund investment while still remaining invested.

Comparison: Mutual Fund vs Fixed Deposit

Factor	Fixed Deposit	Mutual Fund
Returns	6% to 7.5% annually (fixed)	8% to 15% (market-linked)
Risk	Very Low	Low to High (depends on fund type)
Liquidity	Moderate – penalty on early withdrawal	High – redeem anytime (except ELSS)
Taxation	Interest taxed as per income slab	Capital Gains tax – 10%/15% based on tenure
Inflation Protection	Weak – often returns below inflation rate	Strong – equity funds often beat inflation
Income Options	Monthly/Quarterly Interest Payout	Systematic Withdrawal Plan (SWP)
Minimum Investment	₹1000 – ₹5000 depending on bank	As low as ₹500 (SIP)

Returns Comparison with Realistic Example

Let’s assume you invest ₹5 lakhs for 5 years:

• FD (7% annually): ₹5,00,000 grows to approx ₹7,00,000 (before tax)
• Mutual Fund (12% average annually): ₹5,00,000 grows to approx ₹8,80,000 (before tax)

Mutual funds clearly deliver better returns, although with market-linked risk. However, if the investment horizon is 5 years or more, equity or hybrid mutual funds usually outperform FDs in both returns and inflation-adjusted value.

Passive Income with FDs

Fixed Deposits allow a Monthly Interest Payout Option, which makes them suitable for retirees or conservative investors. However, the post-tax real income often ends up being low, especially if you're in the 20% or 30% tax bracket.

For example, if you invest ₹10 lakhs in a 7% FD and choose monthly payout:

• You’ll receive about ₹5,800 to ₹6,000 per month.
• After tax, it may reduce to ₹4,000–₹4,800 depending on your tax slab.

Passive Income with Mutual Funds (SWP)

Mutual funds provide a flexible way to create monthly income through an SWP. Here's how it works:

• Invest ₹10 lakhs in a balanced mutual fund
• Set up an SWP for ₹6,000 per month
• The remaining invested amount continues to grow
• You can adjust the withdrawal amount anytime

This makes mutual funds ideal for creating a growing stream of income over time, especially if the returns consistently outpace withdrawals.

Taxation Matters

FD Taxation:

Interest earned is taxed as per your income tax slab (10% to 30%). Banks also deduct TDS at 10% if total FD interest exceeds ₹40,000/year (₹50,000 for seniors).

Mutual Fund Taxation:

• Equity Funds: Gains above ₹1 lakh taxed at 10% (long-term)
• Debt Funds: Gains taxed as per slab (after 2023 tax changes)
• Dividends are taxed as regular income

Which is Better for You?

The ideal choice depends on your goals:

• Choose FDs if:
• You’re risk-averse or retired
• You need guaranteed income
• You have a short investment horizon (1–2 years)
• Choose Mutual Funds if:
• You’re young and looking for wealth creation
• You want inflation-beating returns
• You can stay invested for 3–5 years or longer
• Smart Strategy: Use a mix of both. Allocate funds to FDs for stability and mutual funds for growth and income through SWP.

FAQs

1. Are Mutual Funds riskier than FDs?

Yes, mutual funds are market-linked and carry varying degrees of risk. But long-term, they often deliver higher returns and beat inflation.

2. Can I get monthly income from Mutual Funds?

Yes, through Systematic Withdrawal Plans (SWP). You choose how much to withdraw every month, just like an FD’s monthly payout.

3. Are Mutual Funds tax-efficient?

Yes, especially equity mutual funds. Long-term gains up to ₹1 lakh per year are tax-free, making them more efficient than FDs.

4. Is it safe to invest in Mutual Funds for passive income?

If you choose large-cap or balanced funds and stay invested long-term, mutual funds can be a relatively safe option for generating passive income.

Conclusion

Both Mutual Funds and Fixed Deposits have their place in your financial strategy. FDs offer stability and guaranteed income, while mutual funds provide higher growth and inflation protection. For those aiming to build sustainable, inflation-beating passive income, mutual funds with SWPs offer superior long-term potential.

Understand your financial goals, assess your risk tolerance, and choose the right mix to make your money work for you.

Let your money grow while you sleep – that's the power of smart passive income!