Is Fixed Deposit a Worthy Investment Option for You?

February 16, 2022 Mutual Fund

Investing in Fixed Deposits is considered to be the safest investment option for those averse to investing in high-risk investment avenues like equities and mutual funds. At the same time, many investors prefer to stay away from investing in Fixed Deposits due to the lower returns and lack of liquidity. This article elucidates the pros and cons of Fixed Deposits and whether investing in them is a good idea.

What is a Fixed Deposit?

The key features and highlights of Fixed Deposits are as follows:

• Fixed Deposit is a financial instrument offered by banks, Non-Banking Financial Companies (NBFCs), and post offices to their customers to help them securely save their money and earn reasonable returns on it.

• It is also known as FD or Term Deposit.

• With a Fixed Deposit account, you can invest your savings for a fixed period at a fixed rate of interest.

• At the end of the term, you receive a lump sum amount back. Each financial institution offers a different rate of interest depending upon the Fixed Deposit term.

• The rate of interest of a fixed deposit is guaranteed and does not fluctuate with the market conditions.

• Even if the financial institution changes the rate of interest for that particular term, they are bound to pay you the same rate of interest they had offered at the time of making a Fixed Deposit.

• You can deposit your savings for a term (duration) based on the available fixed deposit tenures of the banks/ NBFCs, which generally ranges from 7 days to 10 years.

• Once you book a Fixed Deposit for a specific period, no pre-mature withdrawals or partial withdrawals are allowed.

• You can choose from several types of Fixed Deposits, such as Normal Fixed Deposit, Flexi Fixed Deposit, Senior Citizen Fixed Deposit, NRO Fixed Deposit, NRE Fixed Deposit, Tax Saving Fixed Deposit, Children's Fixed Deposit, Employee Fixed Deposit, etc.

• You can also choose to receive the interest upon maturity with a cumulative interest-earning or receive it monthly, quarterly, half-yearly, or yearly.

• Upon maturity, you can choose to automatically receive the funds into your registered Savings Account (if you want, you can again book a fresh FD of this amount), reinvest the entire amount (auto-renewal principal + interest), or reinvest only the principal amount (auto-renewal principal only)

What are the benefits of investing in Fixed Deposits?

1. Security and Assured Returns:

A Fixed Deposit is considered to be the most secured investment instrument as it comes with potentially no risk to your investment, and the returns do not fluctuate with the market conditions. A Cumulative Fixed Deposit can be used as a wealth creation option. When the other riskier financial instruments get affected by the market fluctuations and uncertainty in returns, a Fixed Deposit still offers you the same returns, which could be leveraged while managing your portfolio.

2. Loan Against Fixed Deposit:

Most banks offer a credit facility in the form of a loan or an overdraft facility to their Fixed Deposit account holders. This facility lets you borrow funds at an affordable rate of interest when you urgently need money without liquidating your investment. The rate of interest on these credit facilities is typically 1% to 2% above the interest rate you are earning on your FD. You can borrow as much as 90% of your Fixed Deposit amount.

3. Different Types to Choose From:

As discussed earlier, there are several types of Fixed Deposits you can choose from based on your needs. So, if you want to earn higher returns and do not need monthly or quarterly payouts of interest earned for your day-to-day needs, it makes sense to invest in a Cumulative FD. Similarly, if you want to save your taxes along with earning interest income, a Tax Saver FD is a good option, as there is tax exemption on the principal amount of up to Rs 1.50 lakhs under Section 80C of the Income Tax Act, 1961.

4. Choose investment tenure based on your financial goal:

The money can be invested from a minimum of 7 days to a maximum of 10 years, which gives the investor the freedom to choose the investment term according to their financial goals. So, if you are investing for a long-term goal like a child’s education, you can choose the term of 5 to 10 years. If you think you might require funds anytime in the near future but still want to earn more than the Savings Account interest rate, you can make an FD for a small duration and keep it on auto-renewal so that you do not lose interest.

5. Flexibility to Withdraw Funds:

If you are in a financial crunch, you can withdraw your Fixed Deposit before its maturity date. The pre-mature withdrawal attracts a penalty of 0.5% to 1%, depending upon the amount of the FD. So, in case of any financial emergency, this can help you get the funds instantly after paying a nominal penalty.

What are the risks of investing in a Fixed Deposit?

1. Defaults or frauds by financial institutions:

Although it is not a regular scenario, you cannot deny the fact that there could be financial frauds within the financial institutions that may make you lose your hard-earned money. However, the Deposit Insurance and Credit Guarantee Corporation (DICGC) provides insurance of up to Rs 5 lakhs per person per bank, and this amount includes both the principal and interest amount.

2. Lower Interest Rate:

Earlier the financial institutions used to offer interest rates of above 10% p.a. on Fixed Deposits. However, currently, they are offered at around 5% p.a to 7% p.a., depending on the bank/ NBFC you choose. These returns could be lower than the inflation rate, thus making it a non-advisable option to invest your entire savings.

3. Lock-in Period:

Although the financial institutions let you pre-maturely withdraw your investment, they charge you with a penalty of 0.50% to 1%, which can make a substantial difference depending on the FD amount. Since the interest rates offered on Fixed Deposits are already on the lower side compared to other investment options, the penalty will further reduce the returns.

Should you invest in Fixed Deposits?

Investment in a Fixed Deposit is advisable if you are looking for an investment instrument that offers guaranteed returns for the short or medium-term with lower risk. However, it does not make sense to invest in Fixed Deposits to achieve your long-term financial goals as the interest rates for longer terms are on the lower side. There are several other better investment options for long-term investments with a low to moderate risk. Liquid funds, debt funds, carefully selected equity funds, etc., are some of the examples of mutual funds that can be an alternate investment option to the FDs. These mutual funds have outperformed Fixed Deposits in terms of generating high returns, offering professional management, and better liquidity. This does not mean you should invest all your savings in mutual funds. Remember the idiom “Don’t put all your eggs in one basket”? Well, that stands true when investing. Before investing in a financial instrument, it is crucial to create a robust financial plan, define your investment objectives, assess your risk appetite, and choose the right mix of investment instruments. Therefore, it is advisable to get in touch with a financial expert who can analyse your risk appetite, income, financial goals, etc. and guide you on your investment portfolio.

This article first appeared on PersonalFN here