Fixed deposits have been India's favourite savings instrument for a long time. Its popularity has been largely due to its perceived level of safety, ability to multiply the amount invested and the ease of depositing money at a bank.
However, when you choose to open an FD at a bank or a non-banking financial institution, it is wise to base your decision on the following 5 factors:
When you look at any kind of investment, it is important to see that the money you put in multiples in a way that beats inflation. Let us take a hypothetical situation where Rs 100 in 2018 is worth Rs 75 in 2020. You need to make sure that your money gives enough returns to beat that kind of depreciation in value.
So if you are looking at a long-term fixed deposit where you are parking money to fund your child's investment in say 10 years, you have to consider not only the depreciation in the value of the currency but the inflation in college fees in those 10 years, will the interest you earn be able to beat them?
2. Tax benefits
Income tax charged on the interest earned from these fixed deposits depends on the income tax bracket you fall under. The higher your income, the higher the tax implication. When interest earned is over Rs 10,000 a year, TDS (tax deducted at source) is applicable. So, if your income is within the taxable limit, you will have to submit form 15G/H to the bank at the start to the year to avoid TDS from being deducted.
Considering inflation and the tax implications, you may earn lesser returns on the deposit, sometimes even negative, making FD not a very wise investment. Be sure to check the tax efficiency by taking post-tax returns into consideration.
3. Premature withdrawal
An unexpected need may arise before your FD matures or you may want to shift your deposit to a different financial organisation to take advantage of a higher interest rate. Anticipating situations like these, it is necessary to look at the premature withdrawal charges and whether or not the bank will permit it.
Bank deposits are considered safe as they are tightly regulated by the RBI. In addition, deposits at a bank are insured to the extent of Rs 1 lakh. Non-banking financial companies also provided term deposit services and at a higher rate when compared to nationalised banks. While there are many options to make a deposit, you need to look at the risk element.
Unsecured debentures, for example, offer more than bank deposits but as the name suggests, these are risky because the returns are dependant on the performance of the company. Higher interest rates always come with higher risks.
5. Investment Diversification
With earnings on investment perspective, it is not smart to invest in FDs alone. You can experiment with instruments with higher risks. At the same time, you can diversify within the fixed investment categories with debt mutual funds, debentures, bonds, certificate of deposits, etc. In fact, with debt mutual funds, your money will be put in 20 to 40 different instruments to give you the best returns.