Table of Contents
- Introduction
- What is a fixed deposit?
- The advantages of investing in fixed deposits
- Receive loan against the FD
- Fixed Period
- Low-risk investment
- Flexible pay-outs
- What are the challenges of investing in fixed deposits?
- Tax-returns
- Low interest
- Liquidity
- Is it possible to lose money on an FD with a bank secured by RBI?
- What are the alternatives to fixed deposits?
- The Bottom Line
Introduction
Fixed deposits are among the safest and most convenient investing instruments in the Indian money and capital market. The primary reason is the fixed return on investments and the security process associated with financial institutions.
Fixed deposits can be the best way to kick-start your investment journey. Investors find them easy to understand and earn a fixed income through returns. Interestingly, the higher interest and less tenure provided by other forms of investments lower the attraction of FDs.
This leads to confusion in the minds of investors. This article will discuss the reality behind fixed deposits and help you evaluate if it is the right investment choice for you.
What is a fixed deposit?
Fixed deposit is a conservative option for investment offered by various banking and non-banking financial institutions like banks and post offices. The investor must choose a fixed tenure based on their goals and the FD interest. The interest earned is decided while making the investment and remains fixed. A person can reap interest payments at regular intervals-monthly, quarterly, half-yearly, or yearly. One can also choose to get the interest and the principal money at the end of the tenure.
The advantages of investing in fixed deposits
Some advantages of investing in fixed deposits are
- Receive loan against the FD: During a financial crisis, instead of breaking the fixed deposit and incurring fines, one can take a loan against it. An individual can receive up to 90% of the principal amount as a loan from the same financial institution.
- Fixed Period: Fixed deposits are a convenient way of safeguarding your money since it is kept in a safe place for a fixed period. Moreover, one earns interest throughout the tenure.
- Low-risk investment: Fixed deposits are a safer option for people who don't like taking risks and believe in regularly earning a fixed sum of interest. Unlike mutual funds and other investments, FDs are not dependent on the financial market.
- Flexible pay-outs: The investor can decide the investment term while investing in an FD. The investor can also choose the interval of interest pay-outs as per convenience-monthly, quarterly, yearly, or half-yearly.
What are the challenges of investing in fixed deposits?
Fixed deposits pose less risk and offer fixed income on interests. Yet, there are a few disadvantages of investing in such investments. Below are a few of the challenges an individual faces while investing in FDs
- Tax-returns: Money earned as interest from fixed deposits falls under the taxable income. More than Rs. 40,000 (Rs 50,000 in the case of senior citizens) earned as interest is deducted as TDS under income tax. The limit for TDS has been increased to Rs. 50,000 for interest.
- Low interest: One can't expect to earn high interest from investing in fixed deposits. The interest is fixed, low, and recurring throughout the tenure.
- Liquidity: As the name suggests, fixed deposit investment does not encourage dissolving the lock-in period between the tenure. One is charged a heavy penalty to liquidate before the maturity period. This leads to an overall low interest earned during the whole period.
Is it possible to lose money on an FD with a bank secured by RBI?
While FDs are safer than many other investment alternatives, they are not without risk. In general, you can lose money in a fixed deposit in one of two ways:
- Inflation: FD returns might be affected by rising inflation. For example, if your FD yields a return of 4.5% while the inflation is 7%, you will lose 2.5% of your money. That is why market-related assets such as equities and mutual funds are preferred because they are known to outperform inflation.
- In India, bank defaults have been a common occurrence. The Deposit Insurance and Credit Guarantee Corporation guarantees a maximum of INR 5 lakhs per individual per bank in the event of a bank default. Anything beyond that may not be recovered.
What are the alternatives to fixed deposits?
FDs are low-risk, low-reward investments ideal for older persons and investors seeking secure investments. However, the following investment choices outperform FDs in terms of returns, liquidity, and lock-in period:
Liquid Mutual Funds (7-9% return) are a suitable alternative to fixed deposits since they provide higher interest rates and faster liquidity than the average FD. Thus, you may get your money considerably faster during a crisis without incurring any losses.
You would have to "break" the FD, as we say in India, and even face losses in the case of fixed deposits. Debt funds (interest rate: 8-10%), digital gold (9.5-10%), and conservative mutual funds (11-16%) are some other investing alternatives (8.5-12%). The risks increase, but so does the payout.
The Bottom Line
In general, fixed deposits are not suitable investment alternatives in terms of returns due to the availability of alternative investment options. However, they may appear to be viable solutions for safety. They are often considered safer because they are not directly tied to the markets. Fixed deposits will not attract you unless you are a conservative risk-averse investor.
However, most FDs have a lock-in period. Thus, if you're prepared to invest your money for that period, it may be a good investment. However, you should be aware that there are superior investing choices available, such as asset leasing, peer-to-peer lending, and various liquid funds. In the end, it comes down to what your investment portfolio requires.
Thus, before considering investing or withdrawing your money from fixed deposits, first understand your risk-return ratio, the period you can give your money to grow, and other important factors discussed above.
