Investing in a fixed deposit (FD) is considered a safe and easy investment strategy, especially when you are beginning your personal finance journey. It is common for friends and relatives to recommend investing in an FD when one wins a lottery or gets a fat bonus. Fixed deposits offer a host of benefits such as tax savings, credit score improvement, and even getting a credit card. Moreover, FDs can come in handy during different phases of life such as education, marriage expenses, childbirth, retirement, medical planning, and other exigencies.
Fixed deposits are a popular way of investment for tens of thousands of Indians. To share a bit of trivia, the total corpus of fixed deposits in India stood at ₹12 lakh crores as of January 2023. FDs are marketed as a healthy way to grow money and given the huge investment size, it is natural for first-time investors to assume their safety. But FDs have their share of pitfalls. Here are five crucial steps to ensure you don’t end up losing your hard-earned money.
Step #5: Reason to invest in a fixed deposit
To anybody who is just starting out in investment, an FD is clearly the easiest and safest instrument. It is similar to a savings bank account but provides a higher interest rate. To someone who does not have a handle on spending, FDs can be a no-frills approach to saving money.
Starting an FD is simple. Anyone can start an FD for a tenure ranging from 7 days to 10 years. But remember that fixed deposits come in various shapes and sizes. There are senior citizen FDs, term deposits, flexi-deposits, and even cumulative and non-cumulative deposits.
An FD assures a stable interest payout. You could also use the FD to apply for a personal loan. What’s more, it is easier to break an FD in the event of an emergency. However, an FD may not be the right choice for a 10X wealth generation. So, ensure that you should have the right reasons to invest in FDs.
Step #4: Start a fixed deposit investment with a credible institution to avoid scams
A common mistake among novice investors is falling prey to unregulated deposit schemes.
61-year-old Usha, a retired schoolteacher, recently received her retirement arrears. A day after she got the message from the bank, a telemarketer called her informing her of a lucrative investment idea.
The tele-caller informed Usha that she was the lucky caller of the day. On offer was a sweet 18% interest rate on a fixed deposit of ₹5 lakhs. The caller also promised free insurance for her family.
Usha knew that some banks offered a free insurance scheme with policy riders, but nobody had offered an interest rate as high as 18 percent. So, Usha declined. A week later, she read in the newspapers how a Ponzi scheme had cheated many in her city.
Usha’s experience is a lesson for prospective FD investors to deal only with credible banks and financial institutions. All banks (both nationalized and cooperatives) offer FDs. Most RBI-regulated banks insure FDs for up to ₹5 lakh (under the DICGC scheme) with a guarantee to return the money if the bank goes bust. If you intend to invest more than this, it is advisable to spread your amount with multiple banks.
Post-offices, non-banking financial corporations (NBFCs), housing finance companies, co-operative banks, and small finance banks, offer FDs to collect funds. For the curious mind, some companies offer Corporate FDs (CFDs) to collect funds. The interest rate on a CFD is typically higher than what is offered by banks and NBFCs since there is a significant risk involved. If the company goes bankrupt, there is no guarantee that you will get the money invested.
Step #3: Comparing fixed deposit investment options of different banks
From smartphones to baby diapers, one is taught to compare products to make a rational decision. When it comes to comparing smartphones, one doesn’t just buy a phone based solely on the camera specifications, right? Think about it, the reason for buying an Apple iPhone 14 or Samsung Galaxy is not just the good camera, it is also the processing power, the availability of apps, etc.
Likewise, there’s so much to consider and compare before investing in an FD. For instance, some small finance banks might offer a slightly higher interest rate. Interest rates for senior citizens are generally higher compared to an FD for general citizens.
The credibility of the bank or the NBFC is another factor to consider. Credible banks are a safe place to start an FD. FD investors should also compare penalty charges for premature closure and other features which might vary across banks.
Step #2: Calculating the tax benefit
Banks and financial planners have made investing in an FD a breeze. Opening an FD may seem as easy as ordering a pizza, but it is not. Certainly not, when one has to compute taxes.
If you overlook the math assuming it to be complicated, let us make it easier for you. With a five-year tax saving FD, you can claim exemption on investments of up to ₹1.5 lakhs under Section 80C of the Income Tax Act.
However, for those who have opted for the new income tax regime, there is no benefit in investing in tax-saving FDs.
Step #1: Calculating your personal finance goal
Most health videos recommend pulling a few kilos and a strict diet for a Hrithik-like figure. But we all know that we can’t have a chiseled body by just lifting a few kilos here and there! A simple way to avoid such traps is to pay attention to our goals or things we wish to achieve.
Knowing one’s financial goals could help investors. After all, whether crypto assets or a fixed deposit, it is a commitment to hold or invest X amount of money. And, nothing illustrates this better than Kapil’s predicament. Kapil who received the message of the Diwali bonus of ₹5 lakhs immediately logged into the bank app and invested all of that in an FD with a one-year tenure.
Sadly, Kapil didn’t take into account the Diwali shopping expenses nor did he compare the interest rate offered by other banks. After returning home from work, Kapil’s wife told him about the Diwali expenses. To meet them, Kapil would have to either break the FD by paying a 2% penalty or approach a bank for a personal loan. He could have easily calculated his expenses and made the decision accordingly.
In another case, Satish started doing the math after his father told him how he may have erred in breaking an FD. Satish had inherited his grandfather’s fixed deposit worth ₹10 lakhs in the 90s but abstained from renewing it. Had he renewed the FD, his fortune might have been worth ₹80 lakhs at an average of 7% interest rate for 30 years. Rather than continuing with the FD, Satish chose to invest in shares and real estate which are currently valued at about ₹2 crores.
The FDs would have generated a corpus of ₹80 lakhs, but Satish evaluated his personal finance objectives and zeroed in on shares and real estate. FDs do generate wealth for the long term, but the compounding effect is little compared to other assets. Also, it becomes crucial to keep a watch on the average inflation rate. If this number is higher than the bank interest rate, then one would be giving money to the bank for free. To reduce this risk, smart investors realign their portfolios.
Most personal finance experts advise FDs as a low-risk investment strategy for the short- to medium-term. Besides offering safe and consistent returns, an FD also inculcates the habit of saving. While the steps mentioned above should help you get started, we also recommend reading our other in-depth articles on fixed deposits to help you make an informed investment decision.