We are sure you must have heard about fixed deposits.
When deciding between various investment options, there are several factors that one considers – the investment horizon, risk appetite, tax efficiency, liquidity, growth prospects, and the ease with which these investments can be initiated and managed.
A broader classification is first made within various asset classes – equities, real estate, gold, or fixed income, after which an investor decides the instrument they wish to utilize for investing in that asset class.
Of the factors that an investor considers, a good investment option would be one where several or maximum of these factors are met. For instance, an investment option that is easy to manage, can be redeemed quickly, is of the desired time horizon, and provides assured returns can be considered by someone who is looking for timely, assured inflow of funds.
What are Fixed Deposits?
A fixed deposit can be one such medium of investment. Let us understand it in further detail.
Offered by banks and non-banking financial institutions, a fixed deposit allows an investor to deposit a specified amount at a pre-decided rate of interest for a specific period. At the end of this period, the investor gets back their principal along with the interest, generally calculated on a simple interest basis. Several institutions, though, also levy a penalty for withdrawing the funds ahead of time.
Apart from physical gold, fixed deposits have been a highly favored mode of investment in Indian households for many years now. Estimates suggest that as much as two-fifths of the country’s savings are in fixed deposits, accounting to more than 100 trillion rupees.
The interest rate offered by banks or financial institutions is generally correlated to the prevailing repo rate set by the Reserve Bank of India. The interest rate offered on FDs is generally high when the repo rate is higher, with the reverse also true.
What are the Benefits of Investing in a Fixed Deposit?
1. Risk-Free
The capital invested by an investor remains wholly protected. This means that irrespective of fluctuations that could impact the value of other investments, the capital as well as the interest earned in a fixed deposit remains safe. India’s apex banking authority, the Reserve Bank of India, also offers insurance of up to Rs 500,000, including the principal and the interest amount, for each depositor.
2. Assured Returns
The rate of interest on a fixed deposit is pre-decided, which means that even at the time of making the investment, an investor knows the exact amount that they will be able to redeem, irrespective of any changes in other parameters, including interest rates. For instance, if you have invested in an FD which offers an 8% rate of return per annum over a five-year period, this will remain constant even if interest rates start trending lower from the first year itself.
3. Fixed Timeline
Knowing for sure when the investment will mature, along with the amount of redemption, can help an investor plan their expenses accordingly. For example, if you want funds for your child’s higher education in two years, you can choose your FD in a manner where the redemption will be around the time you need to make the expenses.
4. Easy Operability
FDs are among the easiest to operate. Apart from physical locations, they can be done online in just a few minutes and generally do not require any extra paperwork. Funds can not only be transferred from an existing savings account, but they can also be transferred to the same upon redemption. An investor can also choose to automatically renew the FD if they do not foresee any need for the funds at the time of maturity.
5. Tax Efficiency
Certain FDs also offer the benefit of tax saving under Section 80/C. These generally have a lock-in period of five years and can be used by investors who are looking at optimizing taxes while keeping their capital intact.
6. Higher Returns vis-a-vis Savings Account
A general and important thumb rule of financial planning includes keeping aside around three months of monthly expenses as an emergency fund. An FD can be used for keeping these funds, as it will generally yield a higher rate of return as compared to that offered by savings accounts.
7. Flexibility of Tenure
Perhaps one of the best features of an FD is that it has multiple tenure options, ranging from as little as 7 days to as much as 10 years. This option provides investors with great flexibility as they can accordingly time their investments according to their needs.
8. Loan Against FD
One of the lesser-known and lesser-used features of a fixed deposit is the facility to avail a loan using the FD as collateral. This helps an investor as they need not look for other assets to be used as collateral.
Wrapping Up
While there are several benefits of investing in FDs, investors must also be aware that these investments offer limited scope for growth compared to other asset classes. Most times, FDs are also inefficient in beating inflation, as the post-tax returns often lag the inflationary rate, especially in developing countries such as India.
Ultimately, an investor must make their decisions based on what suits them best considering various factors including risk appetite, understanding of the asset class, and their convenience, among other factors.
Explore a range of FDs on Kuvera and book within minutes using your existing bank account.
FAQs
What is a fixed deposit (FD)?
A fixed deposit is an investment where a specified amount is deposited with a bank or financial institution at a pre-decided interest rate for a fixed period.
How safe are fixed deposits?
Fixed deposits are considered very safe as the capital remains protected. The Reserve Bank of India also insures up to Rs 500,000 per depositor, including interest.
How are fixed deposit interest rates determined?
FD interest rates are generally correlated with the prevailing repo rate set by the Reserve Bank of India, higher when the repo rate is high, and vice versa.
Can I withdraw my FD before maturity?
Yes, but early withdrawal may incur a penalty. It’s essential to check the terms with your bank or financial institution.
What are the tax benefits of investing in FDs?
Certain fixed deposits offer tax savings under Section 80/C of the Income Tax Act, with a lock-in period of five years.
How do fixed deposits compare with savings accounts?
FDs generally offer higher returns compared to savings accounts and can be a better option for emergency funds.
Can I take a loan against my FD?
Yes, many banks and financial institutions allow you to take a loan against your fixed deposit, using it as collateral.
What is mental accounting in the context of investing?
Mental accounting involves treating money differently based on subjective criteria, such as separating savings for specific goals while ignoring higher interest debts, leading to inefficient financial decisions.
Are FDs a good way to combat inflation?
FDs typically offer limited growth and may not always outpace inflation, especially in developing countries like India.
What should I consider before investing in an FD?
Consider factors such as your risk appetite, financial goals, investment horizon, and the interest rate environment before investing in an FD.
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