FDs

  • What is a Fixed Deposit?

A fixed deposit or an FD is an investment instrument that banks and non-banking financial companies (NBFC) offer their customers. Through an FD, people invest a certain sum of money for a fixed period at a predetermined rate of interest in an FD. The rate of interest varies from one financial institution to another, although it is usually higher than the interest offered on savings accounts. Fixed deposits are available for different periods, ranging from very short-term tenures of 7-14 days to long tenures of 10 years. A fixed deposit is sometimes known as a term deposit.

  • How Does a Fixed Deposit Work?

You may think of a fixed deposit as lending money to a bank or an NBFC. When you invest in an FD, the financial institution guarantees to return the invested sum at the end of the tenure, known as the maturity period, and pays you interest for it. The bank may use this money to lend to other borrowers and charges them an interest for the same. A portion of this interest is passed on to you.

The interest offered depends on the tenure or maturity period of the FD. A 7-day fixed deposit will carry a lower annual interest rate compared to a one-year FD. This is to compensate for the time-risk of money. Simply put, a rupee today is more valuable than the same rupee a year from now. This is because inflation pushes up prices over time. A rupee will buy you more goods today than it will a year from now. An investor needs to be compensated for this.

You can choose to reinvest the interest or receive an interest amount periodically in your bank account.

  1. Cumulative FDs pay you the interest and the principal at maturity. The interest is reinvested every year. This means that you will not be eligible to receive regular interest payouts, instead of receiving a lump sum at the end of the FD tenure. The cumulative FD option may be suitable for you if you do not need a regular stream of income. Under this option, you will also benefit from the power of compounding, as the following year’s interest will be calculated on the principal plus interest of the previous year.
  2. Non-cumulative FDs will pay you interest at fixed intervals. You could choose to receive interest payments monthly, quarterly, half-yearly, or annually, depending upon your needs. This will give you a regular stream of income. However, the downside of non-cumulative FDs is that you will lose out on earning interest on interest.
  • Who Should Invest in an FD?

When you invest in a fixed deposit, the duration of investment or tenure and interest amount is predetermined. The institution also assures you to return your money at maturity. That makes FDs a relatively safe investment avenue. Fixed deposits are a good investment option for:

Conservative Investors: People with a low-risk appetite who want to invest but still cannot stomach high risk. FDs provide a higher return than money kept in the savings account.

Investor with Short-Term Goals: Fixed deposits (FDs) are ideal for investors with short-term goals because they offer guaranteed returns and a fixed interest rate, ensuring stability and predictability. Unlike market-linked investments, FDs have almost no risk, making them a safe choice for achieving near-term financial objectives

Balancing the risk in an overall portfolio:  Even for those with a medium-to-high risk appetite, investing a portion of your funds in fixed deposits balances out the risk from market-linked instruments like equity or mutual funds.

Retired Individuals: Retired individuals who want to ensure the stability of investment and earn guaranteed returns can also invest in FDs.

  • Benefits of FDs

Fixed deposits have many benefits such as:

Assured Return:

Unlike market-linked securities that may result in losses due to market volatility, fixed deposits provide an assured rate of return on investments. Your capital remains safe in FDs, and returns are higher than savings accounts.

Compounding:

With FD investments, you can earn interest on interest, thereby enjoying higher returns and faster multiplication of money.

Low Minimum Investment:

If you want to inculcate an investment habit but do not have a large sum to do so, FDs are a good option because investment amounts can start as low as Rs. 500.

Liquidity:

Premature withdrawal of FDs is permitted, although you will lose some interest in the missed duration. However, this gives you the benefit of liquidity since you can liquidate the FD in times of emergencies.

Easy Process:

FDs are the easiest instruments to invest in, both offline and online, through net banking or mobile banking.

Higher Rates for Senior Citizens:

Senior citizens can earn more from their life’s savings and move one step closer to no-compromise retired life.

  • What Role Can FDs Play In Your Portfolio?
Balance in your portfolio

Fixed deposits can provide balance in your portfolio. While market-linked instruments such as equities and mutual funds carry an element of risk, FDs do not. They are safe investments that provide an assured return over a fixed period of time.

Net value of your portfolio remains positive

During market lows, the returns from FDs can ensure that the net value of your portfolio remains positive as the interest earned from FDs can compensate for any losses that your market-linked investments may have incurred.

Suitable for short-term goals

While equities can fulfill long-term financial goals, FDs are more suitable for short-term goals. They are also a wise investment choice for financial goals where you cannot afford to lose the capital investment.