Fixed deposits in India: Benefits, drawbacks and precautions
Any investment portfolio should comprise the right mix of safe, moderate, and risky investments. While mutual funds and stocks are the favorite contenders for moderate and risky investments, fixed deposits, government bonds etc. are considered safe investments. Fixed deposits have been particularly popular among a large section of investors in India as a safe investment option for a long period.
With fixed deposits or FDs as they are popularly known, a person can invest an amount for a fixed duration. The banks provide interest rates depending on this loan amount and the tenure of deposit. Here are the benefits, drawbacks of fixed deposits and precautions one should take while making such investments.
Benefits
1. Safety
The fixed deposits of reputed banks and financial institutions regulated by RBI (Reserve Bank of India) the banking regulator in India are very secure and considered as one of the safest investment methods.
2. Regular Income
Fixed deposits earn fixed interest rates for their entire tenure, which is usually compounded quarterly. So, those who want an income on a regular basis can invest into fixed deposits and use the interest rate as their income. This makes a fixed deposit very popular way of investing money for retirees.
3. Saves tax
With the directives of the income tax department stating that investment in fixed deposits up to a maximum of Rs.100,000 for 5 years are eligible for tax deductions under section 80 C of income tax act, fixed deposits have again become popular. Fixed deposits save tax and give high returns on invested money.
Drawbacks
1. Lower rate of returns
While the money invested in stock markets may give you a return of 20% the fixed deposits will yield only about 10%. So, the money grows slowly in the case of fixed deposits.
2. Taxes
The interest earned on fixed deposits is fully taxable and is added to the annual income of the individual. Gains from stocks are considered capital gains while dividends are tax free.
3. Rising inflation can wipe out the interest benefits
The actual benefits or income from fixed deposit can be annulled by a rising inflation. Suppose the inflation which is currently at 3 % rises to about 6%, your fixed deposit at 10% annual return will effectively yield only(10%-6%) = 4% of return. This return would have been (10% -3%) = 7% if the rate of inflation had not changed. This can drastically eat into your fixed deposit income.
Precautions
1. Company fixed deposits
Company fixed deposits are not considered as safe as fixed deposits from leading banks and financial institutions regulated by the RBI. So, if a company runs into losses or goes bankrupt the money invested into its fixed deposit can be lost. To lure investors, such companies offer a fixed deposit interest rate which is much higher than those offered by banks. Before investing in any company fixed deposit it is advised to check the credentials of the company.
2. Interest rate compounding period
The interest rates offered on fixed deposit vary greatly with banks and tenures. Whether the interest rate is compounded quarterly or monthly will determine how much a person earns from his fixed deposit. A fixed deposit with interest rate compounded monthly will earn more than one which is compounded quarterly. It is therefore advised to shop around for the right fixed deposit scheme.
3. Premature ending of fixed deposits
Banks will impose a penalty if you break your fixed deposit before the maturity period. Make sure you get the facts right about this thing. How the bank calculates this penalty and what all charges will it levy when you break a fixed deposit should be noted carefully.
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