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Fixed Deposit: 5 things to know about FDs to make the right investment decision

FIXED DEPOSIT1Keep in mind that FD returns are completely taxable according to the investor’s income tax slab rate. So, always consider the post-tax FD returns while making a decision.

Fixed deposits are one of the safest and most popular investment instruments available in the country. FDs can offer you good returns provided you know the product well and make informed decisions to be able to maximise the investment benefits. Most banks and many financial institutions offer their investors the facility of depositing money in their FD instruments. But how do you know which is the best FD product for you?

FDs are also available in multiple tenure options and with different features – but how do you select the FD product that best meets your requirements? Read on as we answer a few critical questions to help you make informed decisions about FD investments.

What should be the ideal tenure of an FD investment?

FD tenures offered by banks and financial institutions usually range from seven days to 10 years. Some banks also offer FDs for longer tenures up to 20 years. But how do you know what is the ideal term of your FD investment? You should ideally invest in an FD whose tenure is in complete sync with your financial goals. Depending on your short and long-term goal requirements, you may select the appropriate FD tenure. You should also prefer FDs that offer you the best rate of interest to meet your financial goal requirements. When FD interest rates are expected to go up, you may invest in multiple FDs of different maturities to create FD laddering and benefit from averaging the FD interest rate in the long term.

Should you invest in one big FD or multiple smaller FDs?

Deposits in banks up to Rs 5 lakh are insured through the Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary. So, to completely nullify the default risk, you may avoid exposure of more than Rs 5 lakh in a single bank when you invest in an FD. The better way would be to split your investment into multiple FDs preferably in different banks ensuring the total deposit (i.e. principal plus interest) in a bank doesn’t exceed Rs 5 lakh. Another benefit of having multiple FDs is that you can liquidate one or two FDs to meet any emergency requirement without disturbing the remaining FD investments. But if you keep the entire fund in a single FD, you may need to prematurely liquidate the total investment in a financial crisis after losing a portion of the interest income in penalties.

That being said, having one big FD has some benefits too. You don’t need to keep track of several FD investments; for example, when each of them will mature and when will you have to reinvest them. So, depending on your safety requirements and convenience, you can choose the appropriate option.

Floating vs. Fixed-Rate Term Deposits: Which is better?

Floating rate term deposits (FRTDs) are investment products that offer interest rates linked to an underlying reference rate such as the RBI’s repo rate, 91-days Treasury Bills rate, etc. So, when the reference rate increases, the linked FRTD interest rate also increases and vice-versa. In regular FD products, the interest rate remains fixed till the completion of the booked tenure. FRTDs suit such investors who understand the interest rate direction and can make the right decision accordingly. If you are not sure about the interest rate trend, it might be better to stick to the regular FD products.

Corporate FD vs. Bank FD: Which is better?

If you are looking for a higher interest rate by investing in FDs, you may explore investing in corporate fixed deposits (CDs). The tenures in CDs usually vary from six months to five years. CDs usually offer a higher interest rate than bank FDs, but they can also carry a higher degree of risk. CDs are also not insured by the DICGC if the company defaults in payments like bank FDs (i.e. up to Rs 5 lakh per bank per investor). Also, some banks allow investors to liquidate FDs partially and stay invested with the remaining portion. CDs, on the other hand, do not offer any partial withdrawal facility. As such, you may explore investment opportunities in top-rated CDs after a thorough risk evaluation to bag relatively higher returns if you also have the required risk-taking ability. If you are a risk-averse investor, it might be better to stick to FDs of reputed banks.

Should you wait for FDs to mature or break them prematurely?

Breaking FDs may not be a good idea, especially when the interest rate is expected to fall in the near future. If you break an FD in such a situation, you may not get the same level of interest when you invest again in the near future. You may explore an overdraft (OD) facility against your FD to avoid penalty on premature withdrawals to meet your short-term requirements instead of breaking the FD after reading the applicable terms and conditions.

If your liquidity crunch is expected to remain for the long term and there are chances of an increase in the interest rates in the future, you may prematurely break your FD to meet your financial requirement and invest in another FD at a higher rate of interest in the near future as feasible. This decision should also be based on the availability of loan options to meet your requirements and the comparison of the applicable loan interest rate with the existing FD rate after deducting the penalty for premature withdrawal.

Also, keep in mind that FD returns are completely taxable according to the investor’s income tax slab rate. So, always consider the post-tax FD returns while making a decision. That said, if your FD is close to maturity, you may want to avoid breaking it prematurely and look for other options to meet the requirement.

(The writer is CEO, BankBazaar.com)

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