Fixed deposits or FDs with banks have for long been staple diet for Indian households. Any surplus money would first and foremost go into either gold or into bank FDs. Over time, when interest rates falling people also realized that debt funds and bonds funds were better choices in terms of returns and tax benefits. However, investors need to remember that there are still certain benefits, and very unique benefits, that bank FDs enjoy. Let us look at the concept to an FD and the advantages of fixed deposit investment. Let us also look at the pros and cons of investing in fixed deposits of banks and post offices.
What is an FD and how does it fit into your portfolio?
When you make a deposit in a bank for a predetermined tenure at a fixed rate of interest, it is known as a Fixed Deposit or FD. These bank FDs have been around for a very long time and have stood the test of time. Not only have they delivered good returns but they are also secure and there has hardly ever been a case of any of the scheduled banks defaulting on FDs. So, it is almost like a blue chip investment akin to a gilt edged government security. In fact, FDs are so safe that for most practical purposes they are treated as virtual cash and are treated as a liquid asset. You can also borrow against your FD at any point of time. As part of your portfolio, it will be part of your debt investment and you should use FDs to gain a higher rate of return compared to bank deposits with a short term to medium term perspective.
Key advantages of investing in a bank FD
Here are some of the key advantages that you can derive by investing in a bank FD:
While FDs are not advertised as guaranteed products, for all practical purposes, these FDs by banks are as good as products with guaranteed returns. Irrespective of the amount deposited in an FD, it will earn you interest at the interest rate prevailing at the time of making the deposit. Once the FD is committed for certain tenure then you will continue to earn that rate even rates in the market go down.
FDs offer you a wide range in terms of time frame. For example, you have bank FDs from tenure of 7 days to 10 years, depending on your specific requirements. If you are looking to spread you risk, you can have multiple FDs in the same bank at the same time for different tenures.
In terms of returns, FDs are better than savings accounts with banks with similar safety and also the same tax treatment. Of course, the interest rates change based on the tenure of the Fixed Deposit and also based on the prevailing rates in the market. Normally FDs with higher tenures earn higher rates and senior citizens also earn higher rate of return.
Apart from the flexibility on the tenure of FDs, you also have flexibility on the periodicity of interest payments. You can choose the mode and frequency of interest and it can be monthly, quarterly, or annual. Therefore, FD can almost become like an additional source of income for you. If you don’t need the regular flows, you can also opt for Cumulative FDs in which the interest is reinvested into the FD delivering even better effective yields at the end of the tenure.
If you are senior citizen you benefit from FDs in two ways. Firstly, you earn better Interest Rates for Senior Citizens and the benefit can be as high as 40-50 basis points, which is a huge difference in this low interest rate scenario. Secondly, senior citizens also benefit from a more favourable tax treatment. While normal FDs give a tax exemption only up to interest of Rs.10,000, for senior citizens this limit has been enhanced to Rs.50,000 effective the Union Budget 2018.
While FDs are not liquid in a theoretical sense like a savings account, it is liquid in two ways. Firstly, you can avail a loan against Fixed Deposit up to 90% on the same day and you are only required to pay the differential rate of interest in this case which is around 2%. While it not advisable, you can also break the FD at short notice if required.
Downsides of Fixed Deposits
There are some downsides in a bank FD you need to be aware of. Firstly, the rates of return are lower compared to a debt fund. Secondly, a debt fund participates in capital appreciation when rates go down but there are no such benefits in an FD. Lastly, FD interest is fully taxable and taxed at your peak rate. Debt funds structured as systematic withdrawal plans are a lot more tax efficient.