Are Fixed Deposits still a good Investment? Benefits and Smart strategies

Given their safety and guaranteed returns over time, fixed deposits have been synonymous with investment over the years. This happens because no matter the how economic condition of the country, one can expect fixed returns at the time of investment. Besides, individuals earn interest on the interest amount, accumulating a lump sum amount.

In India, ₹103 trillion has been saved in fixed deposits (FD) across 24.23 million deposits, making it one of the most preferred investment instruments. The reason behind this popularity is that FDs offer safety from market volatility.

Therefore, individuals planning to invest must have a clear understanding of what a fixed deposit is, its types, pros and cons, tax implications and more to make an informed choice.

What is a Fixed Deposit?

The term ‘what is fixed deposit’ is often used interchangeably with ‘meaning of fixed deposit’.

A Fixed Deposit (FD) is a financial instrument issued by financial and non-banking financial companies (NBFCs) that allows individuals to deposit a specific amount for a given duration. In return for this deposit, the investor earns a predetermined interest rate.

Fixed deposits are considered hassle-free and secure options in India due to the assurance of capital protection. They are popular among risk-averse investors looking for steady returns.

7 Types of Fixed Deposits

Fixed deposits can be categorised based on various criteria to suit different investor needs and preferences. By understanding these different types of fixed deposits, investors can choose the option that best aligns with their financial goals, risk tolerance, and investment horizon.

I. Based on Tenure

Type	Tenure
1. Short-term	7 days to less than 1 year
2. Medium-term	1 to 3 years
3. Long-term	More than 3 years

Note: The tenure of a fixed deposit determines the investment horizon. Longer tenors generally offer higher interest rates.

II. Based on the Deposit Amount

Type	Deposit Amount
4. Regular FD	No specific minimum or maximum
5. Jumbo FD	Higher minimum deposit (usually ₹10 lakhs or more)

Note: Jumbo FDs often come with higher interest rates due to the larger deposit amount.

III. Based on the Deposit Holder

Type	Holders
6. Single Holder FD	One individual
7. Joint Holder FD	Two or more individuals

Note: Joint-holder FDs allow multiple individuals to hold the deposit jointly, with survivorship benefits in case one holder dies.

7 Other Types of Fixed Deposits

Cumulative FDs: Interest is compounded and added to the principal at maturity, resulting in a higher final payout.
Non-Cumulative FDs: Interest is paid out periodically (monthly, quarterly, annually) to the depositor.
Recurring Deposits (RDs): A systematic investment plan where a fixed amount is deposited regularly for a specified period.
Senior Citizen FDs: These are offered to individuals aged 60 and above, with higher interest rates to cater to their retirement needs.
Fixed Deposits for NRIs: Specifically designed for Non-Resident Indians, with different terms and conditions applicable.
Flexi FDs: They offer the flexibility to withdraw funds without breaking the FD.
Corporate FDs: Issued by companies, these FDs often offer higher interest rates but carry higher risk.

Factors Affecting Fixed Deposit Interest Rates

Several factors influence the interest rates offered on fixed deposits. Let’s delve deeper into each factor with examples and explanations:

1. Bank’s Reputation and Financial Health

Larger, established banks tend to have a lower risk profile, which allows them to offer slightly lower interest rates.
Smaller banks or NBFCs might offer higher rates to attract deposits due to their higher risk profile.

Example: While HDFC Bank, a large and established bank, might offer a 6.5% interest rate on a 1-year FD, a smaller private bank might offer 7% for the same tenure.

2. Tenure of the FD

Longer tenures generally attract higher interest rates as banks can invest the funds for a longer period.
Short-term FDs typically have lower interest rates as the funds are available for a limited duration.

Example: A 1-year FD might offer a 6% interest rate, while a 5-year FD from the same bank could offer 7%.

3. Amount of the Deposit

Some banks offer higher interest rates for larger deposit amounts to attract bulk deposits. These are often termed as ‘jumbo FDs’.

Example: A deposit of ₹10 lakhs or more might qualify for a jumbo FD with a higher interest rate than a regular FD.

4. Current Economic Conditions

Inflation rates: High inflation can lead to higher interest rates to compensate for the decreasing purchasing power of money.
Monetary policy: The Reserve Bank of India’s (RBI) policy rates (repo rate and reverse repo rate) directly impact FD rates. An increase in policy rates generally leads to higher FD rates.
Economic growth: A booming economy can lead to higher interest rates as banks need to attract deposits to fund loans.

Example: During periods of high inflation, banks tend to increase FD rates to match the rising cost of living.

5. Reserve Bank of India (RBI) Policy Rates

The repo rate is the interest rate at which the RBI lends money to commercial banks.
The reverse repo rate is the interest rate at which commercial banks park their excess funds with the RBI.
An increase in the repo rate generally leads to an increase in FD rates as banks pass on the higher cost of funds to customers.

Example: If the RBI increases the repo rate by 25 basis points, banks are likely to increase their FD rates to maintain their profit margins.

Advantages and Disadvantages of Fixed Deposits

Here’s a tabular representation summarising the advantages and disadvantages of fixed deposits:

Feature	Description
Safe investment option	The principal amount is guaranteed by deposit insurance up to a certain limit.
Predictable returns	Fixed interest rates offer certainty in earnings.
Tax benefits	Interest earned on certain FDs can be tax-deductible under specific schemes
Loan against FD	Banks allow you to borrow a loan using your FD as collateral, providing liquidity.
Lower returns compared to other options	Fixed deposit interest rates may not keep pace with inflation, resulting in lower purchasing power over time.
Liquidity issues	Early withdrawal of funds before maturity typically incurs penalties.
Interest rate risk	If interest rates rise after you invest in an FD, you might earn lower returns compared to new FDs with higher rates.

4 Advantages of Fixed Deposit

Safe investment option: Fixed deposits are considered a safe investment option as the principal amount is guaranteed up to a certain limit by deposit insurance provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC) in India. This offers peace of mind to investors, especially those with a low-risk tolerance.
Predictable returns: Fixed deposits offer fixed interest rates for the chosen tenure. This provides certainty and stability in terms of earnings, which can be helpful for financial planning.
Tax benefits: Some types of fixed deposits, such as tax-saving FDs, offer tax benefits that help you to deduct a portion of your investment amount from your taxable income.
Loan against FD: Fixed deposits help you avail of loans against them. This means you can borrow money from the bank using your FD as collateral without having to break the deposit and incur any penalties.

3 Disadvantages of Fixed Deposit

Lower returns compared to other options: Fixed deposit interest rates generally offer lower returns compared to other investment options like equity shares or mutual funds. Over the long term, inflation may erode the purchasing power of your returns.
Liquidity issues: Fixed deposits typically have a lock-in period, and early withdrawal before maturity may attract penalties.
Interest rate risk: Interest rates are dynamic and can fluctuate over time. If interest rates rise after you invest in an FD, you might be stuck with a lower rate compared to newer FDs offering higher rates.

Tax Implications on Fixed Deposits

The interest earned on fixed deposits is considered taxable income under the category ‘Income from Other Sources’. The government levies a Tax Deducted at Source (TDS) on this income.

TDS on Fixed Deposits

TDS Threshold

For individuals below 60 years: ₹40,000
For senior citizens (60-80 years): ₹50,000
For super senior citizens (above 80 years): No TDS

TDS Rate: 10% if PAN is submitted, 20% if PAN is not submitted.

Snapshot of TDS on Fixed Deposits

Age Group	TDS Threshold	TDS Rate (with PAN)	TDS Rate (without PAN)
Below 60 years	₹40,000	10%	20%
60-80 years	₹50,000	10%	20%
Above 80 years	Nil	Nil	Nil

Exemption from TDS

To avoid TDS, you can submit Form 15G (for individuals under 60 years of age) or Form 15H (for senior citizens) to the bank if your total income is below the taxable limit.

Important Points to Remember

TDS is deducted annually, not at maturity.
If the total interest income from all your FDs exceeds the TDS threshold, TDS will be deducted.
You can claim a refund of excess TDS paid by filing your income tax return.
Tax laws are subject to change. It’s advisable to consult a tax professional for the latest updates and personalised advice.

Note: The interest earned on fixed deposits is added to your total income and taxed according to your income tax slab.

Conclusion

Fixed deposits offer a balance between safety, predictability, and liquidity. They are suitable for low-risk individuals searching for a safe and stable investment option for their short-term or long-term goals.

However, it’s important to consider potential disadvantages, such as lower returns and limited liquidity, before making an investment decision. Understanding these tax implications can also help one manage their investments effectively and optimise their tax savings.

FAQs

1. What is the minimum amount required to start a fixed deposit?

The minimum deposit amount varies from bank to bank. Some banks offer FDs with deposits beginning from ₹1,000.

2. Can I access money before the maturity of my FD?

Yes, you can withdraw money before maturity, but you will be charged a penalty.

3. Is it safe to invest in fixed deposits?

Yes, FDs are considered one of the safest investment options in India, as they are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) for up to ₹5 lakh per depositor.

4. What is the key differentiator between a fixed deposit and a recurring deposit?

A fixed deposit involves a lump sum deposit for a fixed tenure, while a recurring deposit involves regular deposits over a fixed period.