What is fixed deposit | Types of FDs | Altifi - A Bond investment platform

What is a Fixed deposit? Types of FDs Explained

In India, fixed deposits are considered a secure form of investment. Although FDs do not deliver returns as exciting as other investment avenues, they still form a bankable investment avenue for all types of investors, whether conventional or contemporary.

If you are new to FDs, before you invest your hard-earned money anywhere, knowing what is a fixed deposit and the types of fixed deposits can help you make an informed decision. So, let’s look at both and explore a few other aspects of FDs in this article.

What is a Fixed Deposit?

A fixed deposit is an investment type where you invest a lump sum amount for a particular period with a bank or financial institution. The amount you invest accumulates interest at a fixed rate set at the time of opening an FD account. As the FD holder, you can choose to withdraw the interest earned monthly, quarterly, half-yearly, or yearly, depending on your preference, financial goals, and investment tenure.

The bank or financial institution credits the interest (based on your option) in your bank account. Furthermore, you can choose to reinvest your FD or credit the original amount with its interest on maturity.

How Does an FD Work?

So, how does an FD work? When you open an FD account, you deposit a specific amount for a stipulated period, which can range from seven days to ten years. Once you deposit the money, your amount begins earning interest based on the duration you’ve selected.

Let’s look at an example. For instance, let’s say you’ve deposited Rs. 1,00,000, and your interest rate is 8 per cent per annum. You’ve chosen a tenure of five years. The total interest you earn for five years will be around Rs. 48,595, and the total value you earn after five years is Rs 1,48,595. Thus, you would earn nearly 48,595 in five years.

Ideally, you shouldn’t withdraw the amount until maturity (although some banks allow you to do a complete or partial foreclosure of the FD anytime you want with a penalty).

What are the Features of a Fixed Deposit?

A fixed deposit usually features the following.

• Fixed Tenure: Fixed deposits have a predetermined maturity period usually ranging from seven days to ten years. As the depositor, you agree to keep the funds locked in for the duration you choose per your financial goals.
• Fixed Rate of Interest: The interest rate is fixed at the time of investment and remains unchanged throughout the FD’s tenure.
• Interest Payout Options: You can choose to receive the interest monthly, quarterly, half-yearly, or annually or compounded and paid with the principal amount when the FD matures.
• Flexible Tenure Options: You can customize your FD and choose to invest the money for a period of your choice as per the options provided by the bank.
• Premature Withdrawal: As mentioned earlier, you can withdraw your FD partially or fully whenever you want, provided the bank allows you to do so. However, it is recommended that you don’t touch the amount until maturity.
• Nomination Facility: Banks allow investors to nominate a beneficiary who will receive the FD’s proceeds in case of the investor’s death.
• Auto-Renewal: You can choose to renew and reinvest your money in a fixed deposit upon the maturity of the earlier FD. Or else, you can also instruct the bank to credit the money back to the specified bank account.

What are the Types of Fixed Deposits?

Let’s now look at some of the different types of fixed deposits.

Standard Fixed Deposits

One of the most popular FDs, it invests the money for a fixed period at a predetermined interest rate. The period may range between seven days and ten years.

Floating Rate Fixed Deposits

As the name suggests, in a floating rate FD, the interest rate doesn’t remain constant throughout the tenure. Changes in the interest rate correspond to changes in a reference rate, like the RBI’s repo rate or a Treasury Bill Yield. So, when the reference rate changes, the interest rates would also fluctuate. For example, if RBI increases the repo rate, the interest rate on the floating FD will also increase, thus increasing the returns on the investment without requiring you to close or auto-renew the FD.

Tax-Saving Fixed Deposits

Tax-saving FDs are another popular FD investment. However, they are applicable only for Hindu Undivided Families and resident individuals. With such an FD, the investor can claim a tax deduction of up to Rs. 1.5 lakhs under Section 80C. However, it should be noted that only the principal component is eligible for tax deduction. The interest you receive is taxed per the depositor’s taxation slab. Tax-saving FDs have a lock-in period of five years.

Senior Citizen Fixed Deposits

Senior citizen FD can be availed by people who are 60 and above. Banks and NBFCs offer a slightly higher interest rate (usually 50 bps) over regular FD interest rates.

Flexi Fixed Deposits

This is another unique FD investment option that offers the benefits of standard FD and saving or recurring accounts. These FDs provide an interest rate higher than that of a savings bank account. Thus, with this FD, you can earn more on your savings and investments. Furthermore, you can withdraw the money whenever you want before the FD’s maturity date to serve a particular financial need.

Cumulative Fixed Deposit

In a cumulative fixed deposit, the interest you earn gets added to the principal amount, providing you the benefit of compounding. Thus, you get the interest payment only at the FD’s maturity. You can choose this FD if you are looking for long-term investments.

Non-Cumulative Fixed Deposit

In this FD, the interest you earn on the principal is paid monthly, quarterly, half-yearly or annually. You can choose the frequency of interest payment while opening the FD.

Sweep-in Fixed Deposit

This FD is linked to your savings account. The excess balance in the savings account is automatically transferred to the FD account, thus letting you earn a higher interest rate.

How to Select the Right Fixed Deposit?

While FDs are a popular investment option, you should choose the right option based on your financial needs and objectives. Here are some factors to consider while choosing an FD.

• Assess your financial and investment goals. Determine whether you are looking to invest in the long-term, gain short-term benefits or save taxes.
• Research the FD offerings of various banks and NBFCs to determine which one suits your monetary goals the most.
• Compare the interest rates of different banks and NBFCs.
• Preferably, choose FDs that offer flexibility for tenure, premature withdrawals (partial or full), interest payout options, etc.
• Do not forget to check the bank or financial institution’s credit rating before investing your money in their fixed deposit.
• Make sure the financial institution you choose is RBI-regulated and your investment is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). The latter insures deposits up to Rs. 5 lakhs per depositor per bank.
• If you feel confused or overwhelmed or need more comprehensive advice on your savings and fixed deposit endeavours, hire a professional.

What are the Advantages of Investing in Fixed Deposits?

FD investments benefit you in various ways. Some advantages include the below.

• Fixed Returns: FDs offer fixed and predictable returns with an interest rate that remains constant throughout the FD’s tenure.
• High Liquidity: A higher liquidity allows you to withdraw your principal amount any time you want, although with a penalty or loss of interest. In genuine cases, the bank may waive off the penalty as part of its customer-centricity.
• Low Risk: FDs are considered low-risk investments, considering the predictable and reliable returns they provide. Hence, they are a viable investment alternative for people looking to invest in a safe and secure investment with guaranteed returns.
• Flexibility Options: Some FDs are flexible in terms of the interest payout, investment amount and tenure. Furthermore, some banks also link FDs with the investor’s savings account, thus allowing the latter to earn more interest while maintaining liquidity.
• Tax Benefits: Tax-saving FD qualifies your money for tax deductions under Section 80C of the Income Tax Act up to a maximum limit of Rs. 1.5 lakhs per FY.

What are the Disadvantages of Investing in Fixed Deposits?

While FDs are considered a secure investment avenue, you should be aware of some disadvantages of investing in FDs as well. Some cons of fixed deposits include the following.

Low Returns: Unlike mutual funds or equities, FDs offer lower returns. So, on the one hand, where you enjoy stability and predictability, on the other, you wouldn’t earn as much as you could have with stocks or mutual funds.

Inflation Risk: FDs may not always remain tuned with inflation. If the country’s inflation rate is higher than your interest rate, you won’t be able to keep up with the inflation through the money or interest you earn.

Tax on Interest: The interest you earn on FD is taxable. Hence, people in the higher tax slabs may not earn as much.

Reinvestment Risk: Choosing to reinvest your FD money may put you at risk of lower interest rates existing at that time.

No Capital Appreciation: FDs do not provide any appreciation for the capital you invest. Your principal amount would remain the same throughout the tenure.

How are FDs different from other Fixed-Income Securities?

Fixed-income securities are debt instruments that governments or organizations issue to finance their objectives or operational expansion. These offer returns in the form of fixed periodic payments and repay the principal at maturity. Some examples of fixed-income securities include treasury bills, bonds, preferred shares, etc.

Final Words

We hope the above gave you adequate insights to begin journey fixed deposit journey. When in doubt, always consult an expert and know what’s right to do justice to your money. Your bank or financial institution can also help you choose the right fixed deposit types based on your financial requirements and long-term and short-term objectives.

Disclaimer: The contents of this article should not be construed as tax or financial advice. Readers should seek advice from their tax or financial advisor before making any investment decision.