7 Things to Consider Before Investing in Fixed Deposit

Investing money is an important aspect of financial planning and one of the popular investment options is a fixed deposit. It is a type of investment where you deposit a sum of money with a bank for a predetermined period, and in return, the bank pays a fixed interest rate on your investment.

Nowadays, the majority of banks provide fixed deposit services as a desirable investment alternative. This is due to the fact that fixed deposits are designed to offer consistent returns and carry lower risks, which makes them a highly favoured choice for investment. Given the abundance of banks that offer this option, it is crucial to be able to determine which one is the best. Therefore, this article will outline the 7 key factors to take into consideration when investing in a fixed deposit.

7 Factors to Evaluate Before Opening a Fixed Deposit Account 

To maximize your investment returns from fixed deposits, it is essential to analyse these seven key factors:

1. Rate of Inflation

Over time, the value of money diminishes due to inflation, resulting in a decrease in its purchasing power. This means that what you can buy with a certain amount of money today will cost you more in the future due to inflation. As a result, it is important to consider the impact of inflation on investment returns. When investing in any financial instrument, it is necessary to calculate returns after taking into account the inflation rate.

If, for example, your fixed deposit is offering a 5.5% per annum interest rate, and the inflation rate is 6%, your earnings may not be sufficient to counteract the effects of inflation, resulting in a loss of the purchasing value of your money over the long term.

2. Fixed Deposit Interest Rates 

When it comes to fixed deposits, the interest rates are fixed and not impacted by market conditions. However, the interest rates can vary between financial institutions and the fixed deposit term. Typically, financial institutions offer higher interest rates on fixed deposits for longer terms such as 2 to 3 years. For instance, if your preferred bank is offering a 4.50% interest rate for a fixed deposit of 6 months, but 4.75% for a period of 12 months, it makes sense to opt for the latter to earn an additional 0.25% interest if you plan to invest for a year.

However, it's important to conduct proper research and compare rates from different financial institutions before making a decision. It is also essential to keep in mind that high-interest rates offered by some institutions may come with increased risk. It's crucial to consider other factors such as the institution's reputation and financial stability, as some cooperative banks have offered unusually high fixed deposit interest rates and ended up going bankrupt.

3. Tax Deduction 

Wondering how Tax Deduction on FD works? Well, if the interest income on all your fixed deposits exceeds INR 40,000 in a year (INR 50,000 for senior citizens), it will be subject to Tax Deducted at Source (TDS). One way to potentially reduce your tax liability is to invest in a tax-saver FD, which offers tax benefits of up to INR 1.50 lakh in a financial year. However, it's important to note that this type of FD typically comes with a lock-in period of 5 years, during which you cannot withdraw the funds until maturity.

4. Non-Cumulative and Cumulative Fixed Deposits 

When it comes to fixed deposits, there are two types: non-cumulative and cumulative. With a non-cumulative fixed deposit, the interest rate is credited at regular intervals, either yearly or monthly, directly into the FD account. On the other hand, with a cumulative fixed deposit, you have the option to reinvest the interest earned at regular intervals. This allows you to take advantage of the benefits of compounding, and the accumulated interest can be received at the end of the tenure or upon maturity.

The interest on cumulative deposits is usually compounded every quarter and reinvested with the principal amount. This makes cumulative fixed deposits a great choice for long-term investments. On the other hand, non-cumulative fixed deposits are more suitable for pensioners and retired individuals who require regular income to meet their daily expenses.

5. No Capital Appreciation

Although fixed deposits offer better returns than savings accounts, they may not provide inflation-adjusted returns or help you generate wealth in the long run. Therefore, to achieve your financial goals within a specific timeframe, it is essential to diversify your investment portfolio based on your risk tolerance, income, expenses, financial objectives, and investment horizon.

While fixed deposits are a viable investment option, there are several other low- to medium-risk investment options that may offer higher returns than fixed deposits, such as government bonds, debt funds, and debentures. By exploring different investment avenues and diversifying your portfolio, you can increase the potential for higher returns and minimize the overall risk.

6. Premature Withdrawal 

In the event of an emergency, you can withdraw a portion or the entire amount of your fixed deposit before the maturity date. However, premature withdrawals are usually subject to a penalty that varies depending on the bank's policy. Therefore, it is important to carefully consider the consequences of withdrawing funds from your fixed deposit before maturity and evaluate if the penalty charges are worth it in light of the situation.

7. Loan Against Fixed Deposits

One of the key benefits of investing in a fixed deposit account is that it allows you to avail of a loan facility in times of financial emergencies. Banks generally offer up to 90% of the fixed deposit amount as a loan, with the maximum loan tenure restricted to the maximum tenure of the FD. The interest rate charged on such loans can range from 0.50% to 2% over the interest rate earned on the fixed deposit. This is a useful feature for those who may need quick access to funds but do not want to break their FD prematurely and incur penalties.

Final Thoughts

To make the most out of your fixed deposit investment, it's important to consider a few key factors before selecting a scheme. This includes analysing the interest rates offered by different financial institutions, comparing the various tenures and penalties for premature withdrawals, and considering whether a cumulative or non-cumulative scheme is more suitable for your investment goals.

Additionally, senior citizens can enjoy an additional fixed deposit interest rate, which can help them maximize their returns. By keeping these tips in mind, you can choose the right fixed deposit scheme and ensure that your future financial requirements are met.

​# This is a guest article authored by Freo Save. For any enquiries or details, you can visit the author's website.