7 Things Millennials Should Consider Before Investing in a Fixed Deposit

What is a Fixed Deposit?

A fixed deposit or term deposit is a financial instrument offered by banks, Non-Banking Financial Companies, and post offices to their customers to help them securely save their money and earn reasonable returns on it. It allows you to invest your savings for a fixed period at a fixed rate of interest and at the end of the term, you receive the lump sum amount along with interest back.

Here are the 7 important things millennials should consider before investing in a fixed deposit:

1. Interest Rate And Term:

As discussed, the rate of interest on fixed deposits is fixed and does not get impacted by the market conditions. That said, the interest rates differ with financial institutions and the fixed deposit term. For example, financial institutions generally offer the highest interest rates on fixed deposits for 2 to 3 years. Suppose your preferred bank is offering the interest rate of 4.50% for a fixed deposit for the period from 6 months 1 day to 12 months, whereas it offers 4.75% for a period of 12 months 1 day to 24 months. In such a case, if you want to make a fixed deposit for a year, it makes sense to opt for a fixed deposit with an investment period of 12 months and 1 day so that you earn 0.25% higher interest. Apart from this, it is crucial to conduct thorough research and compare different financial institutions to get the best interest rate. However, bear in mind that the rate of interest should not be the only criteria to choose a financial institution, as the financial institutions offer extraordinary higher interest rates than the market rate, which can expose you to high risk. There are ample examples of co-operative banks offering unusual interest rates of fixed deposits going bust.

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2. Returns And Inflation:

As we know, money loses its value, i.e., purchasing power over a period of time due to inflation. The groceries you purchase for Rs 1,000 today may cost you almost double in the next five years, considering the inflation. Hence, it is imperative to calculate returns after considering the rate of inflation while investing in any financial instrument. If your fixed deposit is offering a 5.5% p.a. interest rate, and the rate of inflation is 6%, instead of earning, you might be losing the purchasing value of your money in the long term.

3. No Capital Appreciation:

While fixed deposits offer higher returns than savings accounts, these returns are not inflation-adjusted and do not help you create wealth in the long term. Hence, in order to achieve your financial goals within time, it is advisable to diversify your portfolio based on your risk appetite, income, expenses, financial goals, and investment horizon. Apart from fixed deposits, there are several other low- to medium-risk investment avenues that can offer higher returns compared to fixed deposits, such as debt funds, government bonds, debentures, etc.

4. Investment Options:

There are various options to invest in a fixed deposit. You can choose the suitable option based on your requirements. If you are looking to earn better returns and do not need a regular payout, you can choose to invest in a cumulative fixed deposit. Whereas if you are dependent on your fixed deposit earnings and need monthly or quarterly payouts of the interest earned for your day-to-day needs, it makes sense to invest in a fixed deposit with interest payout. You can also decide about the reinvestment of the maturity amount, i.e., if you want the maturity amount to get credited in your registered savings account upon maturity, then auto-renew the fixed deposit of an entire maturity amount, or auto-renew the fixed deposit of only the principal amount and get the earned interest credited to your registered savings account. Apart from this, you can also invest in a Flexi Fixed Deposit that allows you to automatically create a fixed deposit that is linked to your savings account.

5. Premature Withdrawal:

Most banks give you the flexibility to withdraw your money from the fixed deposit before its maturity. Premature withdrawal is subject to a penalty and other terms and conditions. The banks and NBFCs may charge you 0.5% to 1% of the interest rate of the period for which the deposit remained with the bank.

6. Loan Against Fixed Deposits:

Most banks offer a credit facility as an overdraft or loan to their fixed deposit account holders. This type of credit, where your fixed deposit acts as collateral, is known as Loan Against Fixed Deposit. It allows you to borrow funds at an affordable rate of interest when you urgently need money without having to liquidate your investment. The rate of interest on these credit facilities is typically 1% to 2% above the interest rate you earn on your fixed deposit. You can borrow as much as 90% of your fixed deposit amount.

7. Tax Deduction Benefits:

You can avail of tax benefits of up to Rs 1.50 lakh per financial year under Section 80C of the Income Tax Act, 1961, if you invest in a Tax Saver Fixed Deposit. This type of fixed deposit comes with a minimum tenure of five years and does not qualify for premature withdrawal. Bear in mind that regular fixed deposits with a 5-year or more tenure do not qualify for tax benefits under this act unless you invest in a specific Tax Saver Fixed Deposit.

To conclude:

Investing in a fixed deposit is suitable for you if you are seeking guaranteed returns for a short to medium term with lower risk. However, considering their age, millennials can take calculated risks depending upon their income, expenses, risk appetite, financial goals, and investment horizon. As fixed deposits do not offer inflation-adjusted returns and do not help in building wealth in the long term through capital appreciation, it does not make sense to invest your entire savings in fixed deposits. That said, you can use it as a tool to diversify your portfolio and invest a part of your savings in it, depending on your profile. As they say, "Don't put all your eggs in one basket". There are several other better investment options for long-term investments that involve low to moderate risk. These options, such as liquid funds, debt funds, etc., can be an alternative to the traditional fixed deposit.

Furthermore, for capital appreciation, you can consider investing in carefully selected moderate to high-risk hybrid mutual funds and equity mutual funds. It is crucial to create a robust financial plan, define your investment objectives, assess your risk appetite, and choose the right mix of investment instruments before investing. However, all of this could be overwhelming for a novice investor. Hence, it is advisable to get in touch with a financial expert who can guide you on your investment portfolio, considering your investment profile.

Warm Regards,
Ketki Jadhav
Content Writer