Traditional investment vs. Mutual funds: which beats inflation better?

Investors want to get the best returns possible on their investments. Yet, most Indian investors prefer traditional investment avenues like fixed deposits, Public Provident Fund (PPF) and gold. These are safe investment avenues, no doubt. But what if you could invest in an alternative avenue that offered similar benefits but higher returns?

Mutual funds provide many benefits, and also help you earn inflation-beating returns. This is because there are different fund types such as equity, debt, index, balanced and thematic funds that cater to different investor sensibilities.

Let’s compare traditional investment avenues against different types of mutual funds and find out which avenue fares better.

But before that, let’s first discuss inflation.

What is inflation?

Inflation is the rate at which the price of goods and services increases over a specified period. That means your cost of living goes up overtime. Here’s a simple way you can understand the impact of inflation on your daily life. Today, a litre of petrol costs around Rs. 81 but in the year 2000, the same litre of petrol cost you around Rs. 25. Similarly, the price of other items too has gone up. The general price rise for all goods and services in a country is known as inflation. This could have a severe effect on your savings in the long term if you don’t invest wisely.

Mutual Funds Vs Fixed Deposits

Fixed deposits (FDs) have been a popular investment avenue for Indians for a very long time. They are popular for capital preservation and stable returns. And when you invest in debt mutual funds, you get similar benefits as that of FDs. Moreover, you can enjoy additional perks too. For starters, the debt mutual fund returns are comparably higher than FDs. This is especially essential when you want to earn inflation-beating returns. And unlike an FD, you can also prematurely withdraw from the fund without penalties.

Fixed DepositsDebt Mutual Funds
Rate of Return5-7.5%8-12%
Risk LevelLowModerate
Dividend OptionNoYes
LiquidityLowHigh
Early Withdrawal OptionPenalty levied on premature withdrawalsYou can withdraw funds any time you want

Mutual Funds vs. Public Provident Fund

The Public Provident Fund (PPF) is a popular long-term investment scheme backed by the Indian government. It is well known for its stable returns and tax benefits. The contributions you make towards PPF are eligible for tax deductions of up to Rs. 1.5 lakh per year under Section 80C of the Income Tax Act. Mutual funds offer similar tax-saving benefits through Equity Linked Saving Schemes (ELSS). But the advantage of ELSS funds is the shorter lock-in period.

While PPF comes with a minimum lock-in period of 15 years, ELSS funds have only a lock-in period of 3 years. This gives greater flexibility for investors to utilize their money as necessary. The returns of ELSS funds are subject to market risks, but when you invest for the long term, these risks go down.

  PPF ELSS
Rate of return 8% 12-14% (or higher)
Risk level Very safe (backed by the Indian government) Returns subject to market
risks
Tax benefits Invested amount is exempt from tax at the time of investment, accumulation and withdrawal Invested amount is exempt from tax at the time of
investment, accumulation and withdrawal
Lock-in period 15 years 3 years
Minimum investment limit Rs. 500 Rs. 500
Maximum investment limit Rs. 1.5 lakh No maximum limit

Mutual Funds Vs Gold

Gold has had an exceptional place in the Indian household for a long time. It is not only used for ornamental purposes but also as a safe investment avenue. But in the 21st century, gold investments have got a new makeover. Instead of investing in physical gold, how about investing in mutual funds? This is possible through Gold Exchange Traded Funds (ETFs).

Gold ETFs have the same value of gold and are traded on the stock exchange. With gold ETFs, you can buy and sell much smaller units (even 1 gm) simply and transparently. But if you want to buy physical gold, you need to purchase a minimum amount like 10 grams or so.

  Gold Gold ETF
Safety Need to store them safely;
threat of loss or theft
ETFs are stored in demat
form so no fear of loss or
theft
Pricing Variable pricing. Value can
change from one jeweller to another
Uniform and transparent pricing
Expenses Significant making charges (20-30%) Fund management expenses like expense ratio or
brokerage charges are
much lower (0.5-1%)
Liquidity Can take time to liquidate gold for cash. Not ideal in times of
emergencies
Highly liquid. Can sell
gold ETFs any time you
like.

A comparison of returns

Let’s take an example to find out the best investment avenue for inflation-beating returns.

Imagine you invest Rs. 100,000 in an FD, PPF, gold and mutual funds this year. For this example, let’s take the current inflation rate which is 4.36%.

FD: Assuming a nominal rate of return of 7.5%, you would earn a real profit of 1.6 lakh at the end of 15 years.

Gold: Assuming an interest rate of 10%, you would earn a real return of Rs. 2.20 lakh at the end of 15 years.

PPF: At the current rate of return of 8%, you would earn a real profit of Rs. 21 lakh at the end of 15 years (assuming you invest Rs. 1 lakh each year) for 15 years.

Equity mutual funds: At an average rate of 15%, you would earn a real return of Rs. 35 lakh (provided that you continue your investment of Rs. 1 lakh each year).

Conclusion

It is clear that mutual funds provide the best inflation-beating returns in the long term compared to most other traditional investment avenues like gold, FD or PPF. And in addition to high yields, mutual funds offer additional benefits including tax savings, diversification, professional management and investment discipline. This makes mutual funds a versatile investment platform for Indian investors.

Author: Chakraborty

Dr Chakrabarty is the Chief Innovation Officer of IntuiComp TeraScience. Earlier she was Assistant Professor of Delhi University, a QS ranked university in India. Before that she has held research positions in IIT Mumbai, IIT Chennai and IISc Bangalore. She holds 2 patents and over 20 research publications in her name which are highly cited. Her area of research is in smart technologies, integrated devices and communications. She also has a penchant for blogging and is an editor of Business Fundas.