Term deposits are one of the safest and most popular investment instruments available in the country. FDs can offer you good returns as long as you know the product well and make informed decisions so that you can maximize the benefits of the investment. Most banks and many financial institutions offer their investors the option of depositing money into their FD instruments. But how do you know which FD product is best for you?
FDs are also available in multiple occupancy options and with different functionality – but how do you select the FD product that best meets your needs? Read on as we answer a few critical questions to help you make informed decisions about FD investments.
What should be the ideal duration of an FD investment?
FD mandates offered by banks and financial institutions typically range from seven days to 10 years. Some banks also offer FDs for longer terms of up to 20 years. But how do you know what is the ideal duration of your FD investment? You should ideally invest in a FD whose mandate is in perfect sync with your financial goals. Depending on your short and long term goals, you can select the appropriate FD mandate. You should also prefer FDs that offer you the best interest rate to meet the demands of your financial goals. When FD interest rates are expected to rise, you can invest in multiple FDs of different maturities to create an FD Ladder and benefit from an average FD interest rate over the long term.
Should you invest in a large FD or several smaller FDs?
Deposits in banks up to Rs 5 lakh are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the RBI. So, to completely negate the risk of default, you can avoid exposure of more than Rs 5 lakh in a single bank when you invest in a FD. The best way would be to divide your investment into several FDs, preferably in different banks, ensuring that the total deposit (i.e. principal plus interest) in one bank does not exceed Rs 5 lakh. Another advantage of having multiple FDs is that you can liquidate one or two FDs to respond to any emergency without disrupting the remaining FD investments. But if you keep the entire fund in a single FD, you may have to prematurely liquidate the entire investment in a financial crisis after losing some of the interest income in the form of penalties.
That being said, there are some advantages to having a big FD as well. You don’t need to keep track of multiple FD investments; for example, when each of them will mature and when should you reinvest them. So, depending on your safety and convenience requirements, you can choose the suitable option.
Variable rate or fixed rate term deposits: which is better?
Floating Rate Term Deposits (FRTDs) are investment products that offer interest rates linked to an underlying benchmark rate such as the RBI repo rate, the 91 day Treasury bill rate. , etc. Thus, when the benchmark rate increases, the linked FRTD interest rate increases and vice versa. In regular FD products, the interest rate remains fixed until the end of the reserved mandate. FRTDs are suitable for investors who understand the direction of interest rates and can make the right decision accordingly. If you are unsure of the interest rate trend, it may be best to stick with regular FD products.
Corporate FD vs Bank FD: which is better?
If you are looking for a higher interest rate by investing in FDs, you may want to consider investing in corporate term deposits (CDs). The duration of CDs generally ranges from six months to five years. CDs generally offer a higher interest rate than bank FDs, but they can also carry a higher degree of risk. CDs are also not insured by the DICGC if the company is in default like bank FDs (ie up to Rs 5 lakh per bank and per investor). In addition, some banks allow investors to partially liquidate FDs and remain invested with the remaining portion. CDs, on the other hand, do not offer any possibility of partial withdrawal. As such, you can explore investment opportunities in top rated CDs after careful risk assessment to achieve relatively higher returns if you also have the risk-taking ability required. If you are a risk averse investor, you may be better off sticking to FDs from reputable banks.
Should we wait for the FD to mature or break them prematurely?
Breaking the FD may not be a good idea, especially when the interest rate is expected to drop in the near future. If you break a FD in such a situation, you might not get the same level of interest when you invest again in the near future. You can explore an overdraft facility (OD) against your FD to avoid a penalty on premature withdrawals to meet your short-term needs instead of breaking the FD after reading the applicable terms and conditions.
If your cash shortage is expected to last for the long term and there are chances of an increase in interest rates in the future, you can prematurely terminate your DF to meet your financial needs and invest in another DF at a higher interest rate in the near future as feasible. This decision should also be based on the availability of loan options to meet your needs and comparing the applicable loan interest rate with the existing FD rate after deducting the premature withdrawal penalty.
Additionally, keep in mind that FD returns are fully taxable based on the investor’s income tax rate. So always take the after-tax returns of the FD into account when making a decision. That said, if your FD is nearing maturity, you may want to avoid breaking it prematurely and look for other options to meet the requirement.
(The author is CEO, BankBazaar.com)