Did your parents ask you to open a Fixed Deposit as soon as you got your first salary? We’re assuming yes!
And you most likely shrugged it off or procrastinated? It’s human nature to do so.
For most of our lives, we’ve all been advised to do something or not do something, without being given a reason for it. We often forget to ask “Why” when we’re given any advice. Let’s change that when it comes to taking financial decisions!
If you also got advice about fixed deposits but never understood the reasoning behind it. Today’s the day to learn about it. We’ll elaborate on the why, what, and how of Fixed Deposits.
With platforms like Vittae, we guide you toward Financial Freedom, while answering “why” for every financial suggestion we make.
What is a fixed deposit?
In simple words, a fixed deposit is an agreement between you and a bank.
It is a way of saving money where you give a certain amount of money to the bank for a fixed period (let’s say 1 year).
In return, the bank gives you a promised amount of money (called interest) on top of your original investment.
So, let’s say you give the bank ₹1000 for one year at an interest rate of 5% per annum.
At the end of the year, the bank will give you ₹50 (i.e. 5% of ₹1000) as interest on your investment.
So, you will get back your original ₹1000 plus the additional ₹50 as interest.
Fixed deposits are considered a safe way of investing money. It guarantees the money that you invest and the interest that you will earn at the end of the fixed period.
Now, that you’ve understood the concept of a Fixed Deposit, let’s see what FD means in ‘finance terms’.
A Fixed Deposit allows an individual to deposit a lump sum amount of money with a bank or a financial institution for a fixed tenure at an agreed-upon interest rate.
The interest rate on fixed deposits is usually higher than that of savings accounts. The interest earned on the deposit is paid out at the end of the tenure. At times, it can also be paid on a periodic basis, depending on the terms of the deposit.
Fixed deposits are considered low-risk investments because the interest rate is fixed, and the principal amount is guaranteed to be returned at the end of the tenure.
Tenure is nothing but the fixed time period of the deposit. The tenure of the fixed deposits can range from a few days to several years.
The interest rate offered by banks and financial institutions varies depending on the tenure of the deposit and the amount deposited.
In India, fixed deposits are a popular investment option for individuals who want to earn a fixed return on their savings without taking on too much risk.
They are also commonly used to save for short-term goals like purchasing a car, funding a wedding, or going on vacation.
Key features of Fixed Deposits
Guaranteed Returns
Fixed Deposits offer a fixed rate of interest which is guaranteed for the entire tenure. This means that the amount you earn on your deposit is predetermined and does not change with market fluctuations.
Flexible Tenure
Fixed deposits can be opened for a period ranging from a few days to several years, depending on the bank’s policies. This allows you to choose a tenure that suits your financial goals and needs.
Minimum Investment Amount
The minimum investment amount for fixed deposits varies from bank to bank, but it is usually a few thousand rupees. This makes it accessible to a wide range of investors.
Premature Withdrawal
In case of an emergency, you can withdraw your fixed deposit before the maturity date. However, banks usually charge a penalty for premature withdrawal, and the interest rate may also be adjusted accordingly.
Fixed vs Floating Interest Rates
Fixed deposits offer a fixed rate of interest throughout the tenure, whereas floating rate deposits offer a variable rate of interest that changes with market conditions.
Taxation
The interest earned on fixed deposits is taxable as per the individual’s tax slab. However, senior citizens are eligible for higher rates of interest and tax benefits.
Nomination Facility
Fixed deposits offer a nomination facility that allows you to nominate a person who will receive the deposit amount
Are Fixed Deposits a good choice for everyone?
Fixed Deposits (FDs) can be a wise investment choice for certain investors, depending on their individual financial goals and risk tolerance.
Here are some reasons why:
Low Risk
Fixed deposits are considered low-risk investments because they offer guaranteed returns and the principal amount is protected. This makes them a suitable investment option for those who are not willing to take too much risk.
At Vittae, we do a risk assessment, that helps us analyze your ‘risk level’ to give you a truly personalized financial report.
Guaranteed Returns
As mentioned before, FDs offer a fixed rate of interest for the entire tenure of the deposit. This means you will have a predictable return on investment.
This makes fixed deposits a suitable investment option for those who want to earn a fixed return on their savings.
Easy to Manage
FDs are easy to open and manage. You can open an FD account with a bank or financial institution and manage it online or through a branch.
This makes it a convenient investment option for those of you who want a hassle-free investment option.
Flexible Tenure
FDs offer flexible tenure options, ranging from a few days to several years. This makes them a suitable investment option for those who want to save for a specific financial goal within a set period.
Drawbacks to Fixed Deposits that investors should also consider:
Lower Returns
FDs offer lower returns compared to other investment options like equities or mutual funds. This means that investors may not be able to generate the same level of returns as they would with other investment options.
Inflation Risk
The interest rate on FDs may not keep up with inflation, which can erode the purchasing power of your investment over time.
Liquidity
FDs are not as liquid as other investment options like savings accounts or mutual funds. Premature withdrawal may attract penalty charges and lower interest rates.
In summary, FDs can be a wise investment choice for risk-averse investors who want to earn a fixed return on their savings. However, investors should also consider the lower returns and inflation risk associated with FDs before making an investment decision.
Fixed Deposit Strategies
Fixed deposit (FD) is a popular investment option among people looking for a guaranteed investment return. Here are some different-fixed deposit strategies in simple terms:
Laddering Approach
This means spreading your FD portfolio across different maturity periods. Instead of investing all your money at once in the same FD, you can create multiple FDs with different maturity periods. This can help you have regular liquidity and avoid penalties for premature withdrawals.
Interest Compounding
Banks offer different interest payment options, such as monthly, quarterly, or annually. If you choose to get the interest payment quarterly, you will receive less interest compared to getting it annually. So, it would be better to choose the interest-compounding option to get higher returns at maturity.
Tax Saving FDs
Banks offer tax-saving fixed deposit options where the investor can use tax benefits under section 80C of the Income Tax Act. These FDs usually have a lock-in period of 5 years and offer higher interest rates compared to regular FDs.
Auto-Renewal
If you are not in need of the maturity amount, you can opt for auto-renewal of your FD. This means the bank will renew your FD for another term with the same amount and interest rate. This strategy can help you to achieve a compounded return for a longer duration.
Consider Joint Fixed Deposits
Consider opening a joint FD account with your spouse or parents, which can help to get higher returns with tax benefits. It can also simplify the process of nomination and joint access to the account.
These are some fixed deposit strategies that you can consider based on your investment goals and risk appetite.
BONUS LEARNING
Diversification is an essential strategy for investors to manage risk and maximize returns. Investing solely in a fixed deposit may seem like a safe and straightforward option, but it can limit the potential for growth and leave an investor vulnerable to inflation. Here are a few reasons why investors should consider diversifying their portfolios:
Managing risk
Diversification spreads the investment across various asset classes, sectors, regions, and securities. This helps in managing the risk of investing in a single asset class or market. If one segment of the portfolio underperforms, the other segments may help to offset the losses.
Maximizing returns
Different asset classes have varying performance patterns. Investors can maximize returns and reduce portfolio volatility by investing in several diversified assets. This helps to balance that fixed deposit’s low risk and low returns.
Protecting against inflation
Fixed deposits provide a return at a fixed rate and may not keep pace with inflation. By diversifying one’s portfolio, investors can invest in a mix of assets that provide a return that is at least in line with inflation.
Taking advantage of opportunity
A diverse portfolio may provide access to a wide range of investment opportunities. Investors can tap into the possibilities of alternative investments such as real estate or commodities. These may offer potentially higher returns than a fixed deposit.
Diversification is a critical strategy in managing an investment portfolio. Fixed deposits can serve as a useful and conservative investment ,but it is important to spread the investment across different assets. This will help you maximize potential returns and reduce the risk of loss.
In Summary
Fixed deposits are a popular investment choice among people who want to save their money in a safe and secure way.
It provides a guaranteed interest rate and ensures the safety of the principal amount invested. Additionally, it is a low-risk investment option that offers higher returns compared to other savings accounts.
While there are some limitations, such as the inability to withdraw funds before the maturity period without penalty, fixed deposits can be a useful tool in achieving one’s financial goals.
If you are looking for a low-risk investment option that guarantees returns, then fixed deposits are definitely worth considering.