When it comes to investing in India, fixed deposits still reign supreme. A large majority of the Indian populace still holds FDs in high regard and frequently opts to invest in them. One of the primary reasons for such unwavering popularity is the advantages that a fixed deposit offers. Safety, passive income and compounding are a few of the benefits offered by it.
However, while fixed deposits are a great investment option, it is far from flawless. It has its own set of disadvantages as well. As an investor, you need to know what they are so you can make an informed decision. So, here’s a quick look at some of the key disadvantages of fixed deposits.
The interest that you get from a fixed deposit is classified under ‘Income from Other Sources’ and is taxable in the hands of the investor. Since the FD interest is added to your total income and then taxed, the tax rate applicable to you is dependent on your income slab rate. For instance, if you fall under the 20% income tax bracket, your interest on FD will also be taxed at 20%.
In addition to this, investors are also subject to TDS (Tax Deducted at Source), where the interest on FD is paid out after the deduction of tax. The rate of TDS on fixed deposit interest is 10% if you’ve submitted your PAN details; if not, the rate is 20%. The tax component on FD interest ultimately ends up reducing the returns that you get from your investment.
Although fixed deposits are safer than other investment options, it comes at a cost - lower returns on investment. The rate of FD is dependent on factors such as the bank, the tenure and your age. Generally, the rates are lower than other investment options, which is one of the major disadvantages of fixed deposits.
The return from an investment, after accounting for taxes, should ideally be more than the current inflation rate. However, in most cases, the rate of interest on a fixed deposit usually tends to be lower than the inflation rate.
For instance, let’s say that the present inflation rate is 6.8%. And that you fall under the 10% income tax bracket. In this case, the interest rate on your FD should ideally be at least 7.7% per annum or more to be able to beat inflation after accounting for taxes.
If a fixed deposit doesn’t offer inflation-beating returns, investing in them is inadvisable since the returns won’t be enough to cover the increase in the cost of living.
Another one of the disadvantages of fixed deposits is that the interest rate is fixed at the time of application itself. Once you open an FD at a particular rate of interest, you continue to generate interest at the same rate till the end of the tenure.
Even if the interest rates rise after you’ve invested in an FD, you will not be able to enjoy the higher rate unless you prematurely withdraw the deposit and create a new one at the new interest rate. Such a scenario is highly disadvantageous from an investor’s standpoint.
A fixed deposit is not as liquid as other investment options. Once you create a deposit for a particular tenure, you will have to stay invested till the end of the tenure. In the event of an urgent cash requirement, you may not be able to mobilise funds since they’re locked in an FD.
However, some banks offer fixed deposits with a premature withdrawal facility. This allows you to liquidate the deposit before the end of the tenure. Additionally, a few other banks also offer loans against FDs to solve the lack of liquidity. But opting for this option would mean that you would have to pay interest on the loan, which is an added financial burden.
The premature withdrawal facility on FDs is a great feature to have. But they do come at a cost. When you opt to prematurely withdraw your fixed deposit, banks generally tend to levy a penalty. The rate of penalty can range anywhere from 1% to 3% of the accumulated interest.
For instance, let’s say that you’ve invested ₹1 lakh in a fixed deposit for a tenure of 5 years at a rate of 10% per annum. However, by the end of the first year, you choose to prematurely withdraw your FD. The bank levies a penalty of 1% on the accumulated interest. This would mean that you would lose around ₹100 [₹1,00,000 x 10% - (₹1,00,000 x 10% x 1%)] from your interest. Though this might seem inconsequential, the higher the interest, the higher would be the penalty.
So, there you have it. These are some of the disadvantages of fixed deposits. Despite these drawbacks, FDs continue to dominate the Indian investment space. However, if you’re looking for investment options that offer higher returns and don’t mind taking on a bit of risk, then consider investing in the stock market. Although investing in market-linked securities may be a little risky, they have the potential to generate high returns in the long run.