Recurring Deposits Vs Mutual Fund SIPs: Understand These Differences Before Investing

For investors who want to invest a specific sum periodically, recurring deposits (RDs) and mutual fund systematic investment plans (SIPs) are two of the most popular options.

Although both favour disciplined saving and suit those with a steady income most appropriately, they vary in terms of returns, flexibility, and risk. Understanding how RDs function and how they vary from SIPs can help you make the right financial choice based on your requirements and risk appetite.

How RDs Work?

An RD is a deposit scheme offered by banks and post offices. It allows individuals to invest a fixed amount every month for a given period—between six months and 10 years. The interest is compounded on a quarterly basis and is awarded along with the full deposit at maturity. The deposit rate on RDs is typically 4-8 per cent annually.

For instance, if you deposit Rs 2,000 each month for two years in an RD with a deposit rate of 6.5 per cent per annum, the amount that you will receive at the end will include both the invested amount in instalments along with the interest.

The rate of interest remains constant through the tenure of the RD. Also, RDs with banks and non-banking financial companies (NBFCs) are insured up to Rs 5 lakh under the Reserve Bank of India’s (RBI) Deposit Insurance and Credit Guarantee Corporation (DICGC) scheme. Post office RD schemes are backed by the Government of India.

What is an SIP?

SIP is a method of investing that involves investing a particular amount on a regular basis in a mutual fund scheme—usually every month. However, some mutual funds also allow SIPs on a daily, weekly, fortnightly, quarterly, half-yearly, or annual basis. SIP is not a product in itself but an investment methodology in market-linked instruments.

One can start an SIP with as little as Rs 100 per month and can continue investing for a minimum of six months. The returns depend on the performance of the mutual fund, which in turn is linked to market conditions. Over the long term, equity SIPs have the potential to generate higher returns than RDs, but they come with market risks.

Key Differences Between RDs and SIPs

• Returns: RDs offer a fixed return, while the returns from SIP investments in mutual funds are variable and depend on the performance of the market. Hence, RDs are suitable for investors who want assured returns, while SIPs are suitable for investors who are comfortable with some risk in the expectation of higher returns.

• Risk: RDs entail little risk as they are not market-related. SIPs, especially in equity mutual funds, entail market-related risks and may cause losses if the markets are unfavourable.

• Liquidity: Premature withdrawal of an RD can attract charges or low interest. SIPs offer greater liquidity, where you can halt investments at any point and sell units partially or in full, though exit loads and capital gains tax may be charged.

• Taxation: Interest earned by RDs is completely taxable under the investor's tax slab of income and TDS is applied if the interest exceeds Rs 40,000 a year (Rs 50,000 for senior citizens).

• Taxation from SIPs investments is based on the fund category and duration of holding. The capital gains from equity mutual funds are taxed at 20 per cent if held for less than a year. If held for more than a year, capital gains in excess of Rs 1.25 lakh are taxed at 12.5 per cent.

• Purpose: RDs are more suited for short and medium-term requirements, such as buying an electronic gadget, a travel, holiday, or saving for a rainy day. SIPs are best for creating long-term wealth for goals such as retirement, higher education, or buying a house.

Which One to Choose?

Whether you should go in for an RD or a mutual fund SIP should be based on your investment objectives, risk tolerance, and investment duration. If you require safety along with a fixed return for a period of time, an RD is ideal. But if you have a need for creating wealth over the long term and can bear little volatility of the market, SIPs will be more rewarding in the long term.