One of the most common and hugely popular investment options for investors since early times is fixed deposits. These fixed deposits were a go-to option for investment especially for the older generation as it was considered to be the safest form of parking your money.
Fixed deposits can be opened with any bank for a fixed period of time. The bank keeps the money of the investors during this period and provides them with fixed regular interest on it. Upon maturity, the amount can be withdrawn easily with interest.
While they are often the first step in building a beginner’s investment portfolio, fixed deposits have many pros and cons. Let us have a close look at them here before making an investment decision.
What are the pros or advantages of investing in fixed deposits?
Fixed deposits have multiple advantages especially when it comes to safeguarding the capital and earning risk-free returns.
Major advantages of fixed deposits
1. Safety of capital investment
Fixed deposits belong to the safest class of investments. The capital investment made in a bank fixed deposit is not subject to any reduction or fluctuations. The deposit is returned to the investor after the completion of the tenure. Even in case of the liquidation, amalgamation, merger, or reconstruction of the bank, the FD of the investor is secured up to Rs. 5,00,000 per depositor (principal and interest included) as per the rules of DICGC (Deposit Insurance and Credit Guarantee Scheme)
2. No risk of market fluctuations
Interest rates on fixed deposits are free from any market fluctuations and hence, returns are fixed unlike returns on other investment products like mutual funds, or equity instruments, ETFs, etc.
3. Tax saving FD
One of the main attractions of investment in fixed deposits is the benefit of tax deduction. The amount invested in a fixed deposit is eligible for a tax deduction of up to Rs. 1,50,000 under section 80C of the Income Tax Act, 1961. But these FDs cannot be withdrawn before the completion of the term of 5 years.
4. Assured returns
The interest rate on fixed deposits is fixed by the banks as per their guidelines. This interest is paid at regular intervals without any interruptions or hassles. Currently (June 2021), the maximum interest paid on fixed deposits by most banks is in the range of 3% to 6% per annum. Senior citizens get the benefit of interest at a slightly higher rate than regular FD rates.
5. Loan against FD
Investors also get the facility to avail a loan from the bank against their fixed deposit held with that bank by using it as collateral. The rate of interest on such loans can also be relatively lower as per the rules of the bank in this regard. Investors can get a loan of up to 90% of their FD held with the bank.
6. Flexible payout of interest
Investors get the option to choose the duration of the interest payout to be paid by the bank on FDs. investors can choose to receive the interest monthly, quarterly, annually or at the time of maturity of the FD as power their discretion and convenience. If the investors do not opt to cash out the interest at regular intervals they are re-invested in the fixed deposit and they get the benefit of compounding.
7. Fixed tenure
Investors can invest in the fixed deposits of the bank for a fixed tenure or period of time ranging from as low as 7 days up to 10 years. Many banks provide the facility of renewal of the FD for a further similar tenure at the maturity of the FD at prevailing interest rates.
What are the cons or disadvantages of investing in fixed deposits?
After considering the above advantages of investing in fixed deposits, let us now consider the cons of investing in FDs.
1. Low returns
The returns or the interest earned on the fixed deposits is quite low as compared to other investment options like mutual funds, ETFs, Government Bonds, etc. hence it cannot be considered a good option to rapidly increase the investor’s wealth.
2. Lower liquidity
FDs are opened for a fixed period of time. Tax saving FDs come with a tenure of 5 years and cannot be closed during such time. Banks have an option to refuse payment of the FDs before the competition of the tenure but it is rarely practiced. Withdrawing from the FD is known as premature closing of the FD and banks can also levy a penalty on such premature closure of the FD account.
3. Taxable interest income
The interest earned by the investor through FDs is a taxable income in their hands and is taxed at the applicable slab rates. If the interest earned by the investor in any financial year exceeds Rs. 10,000, banks are liable to deduct TDS at the rate of 10% on such interest income. If the investor’s interest income from FDs does not exceed Rs. 10,000 during the financial year, they can submit Form 15G (investors below the age of 60 years) or Form 15H (investors above the age of 60 years) to avoid TDS.
Difference between debt mutual funds and fixed deposits
Debt mutual funds are mutual funds that invest primarily in debt instruments and like FDs, they aim at providing consistent returns to their investors. However, there are major underlying differences between the two. Debt funds are a dynamic investment option and can give better returns to investors especially in an economy with low interest. Given below are the ways in which debt funds are a better investment option than FDs.
|Debt mutual funds
|The returns FDs are in the range of 6% to 8% annually and slightly higher in the case of senior citizens.
|Returns on debt mutual funds are higher than that of FDs and the average returns can be around 9%. The returns will be further higher if the investor will stay invested for a longer duration or depending on the fund performance
|The risk of investment in FDs is lower than Debt mutual funds. They are not influenced by any market highs or lows
|Debt mutual funds are also a safer investment o[ption but the risk is slightly higher than that in FDs
|Investors can invest in FDs for a fixed tenure starting from 7 days up to 10 years.
|There is no fixed investment tenure in the case of debt mutual funds
|FDs are known for being less liquid assets. Premature withdrawal of FDs is allowed by banks but usually at a penalty
|Debt mutual funds like any other mutual funds are highly liquid.
|Returns from FDs are taxed at the investor’s applicable slab rates.
|Debt mutual funds are subject to capital gains tax. Short-term gains are taxed at applicable slab rates whereas long-term capital gains are taxed at 20% after indexation. Hence, for an investor in the highest tax bracket, investment in debt funds is better than FDs
|Mode of investment
|Investment in Fds can be done only through lumpsum mode.
|Investment in debt mutual funds can be done through either SIPs or lumpsum
Fixed deposits are considered to be a low income-generating investment option and often preferred by only senior citizens. But the returns are guaranteed and the investment is safe from any market fluctuations. This makes it a good investment option despite limited returns, especially for beginners. It is also a good option for parking emergency funds needed in the investor’s portfolio.
1. When are FDs an attractive investment option?
A. In a situation of high inflation when the RBI increases the lending rates and the rates on FDs, they become an attractive investment option for the investors.
2. What is the minimum interest rate on FDs?
A. The current minimum interest rate on FDs is approximately around 4%. This depends upon many other factors like current benchmark rates set by the RBI, economic situation, etc.
3. What are the different types of FDs offered by banks?
A. The different types of FDs offered by banks include,
- Recurring deposits
- Tax saving deposits
- FD for senior citizens
- NRO FD account
- NRE FD account
- Corporate FD account
4. What are Flexi Fixed Deposits?
This is a feature provided by many banks on their savings accounts balance. Any amount in excess of an earlier fixed amount is automatically transferred into a fixed deposit account that earns more than the savings interest rate. This is also called a Sweep-In Fixed Deposit.