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What you must know about FDs

FDs are very popular products in the Indian investment landscape. But are they the best product for you? Clearly, they come with the promise of guaranteed returns, which gives investors some security. But, they are poor protection against inflation, and offer poor liquidity. So what do you need to know about them?

What is an FD?
What are the different types of FDs?
What are the advantages of FDs?
What are the disadvantages of FDs?
Can I get any tax benefits with FDs?
Who are best suited to invest in FDs?
5 things to watch out for in FDs

What is an FD?

A Fixed Deposit (FD) is an investment option that allows you to invest a lump of money for a fixed time period and at a fixed rate of interest. During the course of the FD, even if the prevailing interest rates go up or down, you will be entitled to only the rate of interest that was promised to you when you first made the deposit.

Whereas your savings bank account might give you only 3.5% rate of interest, FDs on the other hand are expected to pay a much higher rate of interest (currently in March 2009 around 8.5%). The interest can be paid to you quarterly, half yearly or annually. If you are a Senior Citizen, you might be able to get up to 0.50% higher rate of interest on your FD. Top

What are the different types of FDs?
There are two types of FDs:

1. Bank FDs: These are offered by banks or non-banking finance companies. These institutions are regulated by the RBI and these deposits are also guaranteed up to Rs 1 lakh per account
2. Corporate FDs: These are offered by corporates who are looking to raise money from the open market. Corporate FDs typically pay a higher rate of interest, but also carry a higher risk than bank FDs Top

What are the advantages of FDs?
The following are some advantages of FDs:

• FDs offer a guaranteed return: FDs are usually secure and are very low risk investments
• You can raise a loan against your FD: After a certain minimum period of the FDs existence, you might be able to borrow up to 85% - 90% of the deposit amount
• Low maintenance: Unlike other investments like stocks, mutual funds or even real estate, you don't need to monitor your FD on a daily or monthly basis, or require any kind of maintenance work
• You can get a maturity of anything from 6 months to 10 years Top

What are the disadvantages of FDs?

• Low returns: Because FDs are very low risk instruments, they offer low returns comparable to alternative investment options
• Lock ups: Your money will be locked up in an fixed deposit for the duration of the deposit. As a result, unlike a savings back deposit, you will lose the flexibility access your funds as needed. You can break your FD if needed, but you will likely have to pay some penalty
• Unfavourable tax treatment: Unlike other investment options such as stocks or mutual funds, interest income earned from FDs will be taxable at your eligible tax rate. Top

Can I get any tax benefits with FDs?

• Under section 80C, you can get a tax deduction of up to Rs 1 lakh per annum if you invest in a 5 year FD. However, the interest you earn on the deposit will be taxed at your eligible tax rate and added under head "Other Income"
• If the aggregate interest income from your FD that you are likely to earn for all your deposits held in a single branch is greater than Rs 10,000 in a financial year, then TDS will be deducted. Tax liability for TDS purposes is determined at branch level, so you might want to spread your FDs across different branches Top

Who are best suited to invest in FDs?

Just like not all medication is suitable for all patients, FDs are also more suitable for some types of investors over others. FDs are most suitable for:

• Risk averse investors, want visibility and security
• Locking up money for a short-term in order to fund an immediate financial goal
• Older people who cannot risk losing money
• Secure investments in a low inflation environment

However, if you are looking to create a lot of wealth and need regular access to your capital, then an FD is not a suitable investment option for you. Top

5 things to watch out for in FDs

1. Always appoint a nominee on your FD for quick withdrawals, and to avoid hassles
2. FDs from corporates might be higher paying but come at a much higher risk than bank FDs. If possible, avoid corporate FDs
3. In times of rising inflation, avoid FDs because your money will lose its purchasing power
4. When making a deposit, check the penalty clause for an early withdrawal
5. A rate which might seem higher upfront might have a lower return if it is not compounded as frequently. For example: Bank X offers a one year deposit at the rate of 9% compounded half yearly - which results in an yield of 9.2%. While Bank Y offers a one year deposit at the same rate of 9% but compounded quarterly - which results in an yield of 9.3%. You will earn more interest on fixed deposits at Bank Y because your return is compounded quarterly. Top

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