Investing in Fixed Deposits During a Market Crash: Is It a Smart Move?

During economic uncertainty and stock market downturns, investors often seek stable investment options to protect their capital. A study in the Journal of Advanced Research in Accounting and Finance Management (2024) shows that almost 90% of stock market traders lose money. This shows how dangerous volatile markets can be. 

Seeing stock values fall can be disturbing, which drives many people to move their money to more secure sources, including fixed deposits (FDs). Because of their dependability and guaranteed returns, FDs are preferred for providing stability during market turbulence. But is this the right move? Let's take a step back and analyse the situation.

Understanding Fixed Deposits

A fixed deposit is a financial product offered by banks and non-banking financial companies (NBFCs), providing a higher interest rate than regular savings accounts. The key feature of FDs is that the deposited amount remains locked for a specified tenure, with premature withdrawal incurring penalties. 

During a downturn, investors often rush to safety, liquidating their equity positions and parking funds in fixed deposits. The appeal is clear—FDs provide guaranteed returns and capital protection, offering a sense of stability amid market chaos.

However, this reaction is largely emotional. While it may reduce short-term anxiety, it can have long-term consequences, particularly if investors lock in low FD rates and miss out on future market recoveries.

Reasons For Stock Market Crashes

There are various reasons for a stock market crash. Let us take a look at some of these:

1. Economic Slowdown 

Companies' revenues and sales drop as individuals have less money to spend, therefore affecting the slowing down of the economy.  Companies respond by cutting expenses through layoffs or hiring freezes, lowering consumer expenditure.  Lower discretionary income resulting from job losses aggravates the slowdown.

Furthermore, companies can cut back on their intentions for expansion when earnings drop, therefore lowering the rate of any ongoing or intended development projects.  One negative economic news event can cause stockholders to panic and liquidate their shares, raising market volatility. This starts the stock market on a declining spiral.

2. Interest Rates 

Interest rates established by a nation's central bank influence borrowing and expenditure.  Lower rates inspire expenditure; higher rates make borrowing expensive and slow down economic activity.  While inflation is low, central banks lower rates; they raise them to help control it. Investors can sell stocks expecting weaker economic growth if they believe rate increases resulting from increasing inflation will be necessary.

3. Geopolitical Events 

Geopolitical events including wars, trade conflicts, and terrorist acts shape investor decisions.  When a nation deals with these problems, its future becomes hazy and investors prefer clarity.  Investors thus would rather wait on the sidelines and watch the market than continue to be engaged.  Faced with possible losses, they thus sell their positions.

For instance, Russia supplies India mostly with oil.  Many investors liquidated stocks as the Russia-Ukraine crisis started in 2022, which caused Sensex and Nifty to drop over 5%. The future became uncertain.

4. Interaction Of Bull Market, Bear Market, And Stock Market Bubble

A stock market crash often unfolds when the economy overheats, inflation spikes, and market speculation reaches unsustainable levels. Rising economic uncertainty fuels investor panic, triggering a market downturn that starts as a correction but can escalate into a full-blown financial crisis. The interplay between a bull market, bear market, and stock market bubble creates volatility, influencing investment strategies, asset valuations, and overall market sentiment.

5. Tax Implications Amid Market Volatility

Tax policies play a crucial role in mitigating the impact of inflation and protecting investment returns. A key approach involves adjusting the tax base by allowing deductions on the portion of nominal income eroded by inflation. While nominal taxable income remains unchanged, real taxable income declines, reducing the tax burden on investors. This strategy helps offset the loss of purchasing power, promotes capital preservation, and ensures a more stable investment environment during economic fluctuations.

Why Fixed Deposits Gain Popularity During Market Crashes

Stock market crashes lead to substantial declines in equity values, prompting investors to seek low-risk alternatives. During recent market turmoil, India's equity benchmark indices, BSE Sensex and Nifty50, experienced significant declines, with Sensex falling below 73,600 and Nifty50 slipping under 22,250. This instability has driven many investors towards fixed deposits due to their advantages:

1. Capital Security: Unlike stocks, FDs are not subject to market volatility, ensuring that the principal amount remains intact.

2. Fixed Returns: The predetermined interest rate provides a steady income, irrespective of external economic fluctuations.

3. Deposit Insurance: In India, bank deposits are insured up to Rs 5 lakh per depositor, adding an extra layer of security.

When Fixed Deposits Make Sense

Fixed deposits can be a valuable component of a diversified portfolio, especially in the following scenarios:

Short-Term Goals: If you need liquidity within the next year or two, an FD ensures your capital remains secure.

Low-Risk Appetite: If market volatility is too stressful and affecting financial decisions, allocating a portion of your portfolio to FDs may help.

Emergency Funds: FDs offer better returns than a savings account while maintaining accessibility.

The Smarter Approach: Diversification

Rather than an all-or-nothing approach, a well-structured asset allocation can help balance risk and reward. Consider maintaining:

• 10-30% in fixed income instruments, including FDs for stability.
• 30-40% in large-cap equities for steady growth.
• The remainder in mid- and small-cap stocks for higher potential returns over time.

FD Laddering: A Strategic Investment Approach

Selecting the right FD can be challenging due to varying tenures and interest rates. FD laddering effectively diversifies investments across multiple FDs with staggered maturities, ensuring liquidity, risk management, and return optimisation.

FD laddering involves splitting an investment into several FDs with different maturity periods instead of placing all funds into a single long-term deposit. For instance, instead of investing Rs 5 lakh in one five-year FD, an investor can allocate Rs 1 lakh each into five FDs maturing in 1, 2, 3, 4, and 5 years. As each FD matures, the amount can be reinvested at prevailing interest rates, maintaining a continuous cycle of growth and liquidity.

Benefits of FD Laddering

For enhanced safety, investors should distribute FD laddered deposits across various banks, ensuring each deposit remains within the Rs 5 lakh insurance coverage limit set by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

1. Mitigates Interest Rate Risk: Interest rates fluctuate, and locking funds at low rates can reduce returns. FD laddering allows reinvestment at better rates over time.

2. Ensures Liquidity: Instead of being locked in for long durations, funds mature periodically, making them available for financial needs.

3. Avoids Early Withdrawal Penalties: Since part of the investment matures regularly, investors can avoid breaking long-term FDs and incurring penalties.

4. Aligns with Financial Goals: Short-term ladders (1-3 years) suit immediate needs like home improvements, while long-term ladders (5-10 years) are ideal for retirement planning.

Key Considerations Before Investing In Fixed Deposits During a Market Crash

While FDs provide security, investors should evaluate certain factors before making a decision:

A. Inflation Risk: Fixed returns may not always outpace inflation, potentially eroding purchasing power over time.

B. Opportunity Cost: Shifting funds to FDs during a market crash might mean missing out on potential stock market rebounds.

C. Interest Rate Trends: The Reserve Bank of India (RBI) adjusts repo rates based on economic conditions, affecting FD interest rates. Many banks recently revised their FD rates following an RBI rate cut.

D. Liquidity Constraints: FDs require funds to be locked in for a specified period, and early withdrawal incurs penalties.

Conclusion

Historically, markets have always rebounded. For instance, equity markets that suffered severe corrections have often delivered robust returns over longer periods. Investors who move their capital to FDs during downturns risk missing the subsequent market recovery.

Let's consider a five-year perspective. Equities, despite their volatility, have significantly outperformed fixed deposits over time. A balanced approach, rather than a full shift to FDs, could be more effective in preserving and growing wealth.

Grip Invest provides alternative fixed-income products such as asset leasing and corporate bonds for investors seeking secure yet high-yield investment options. These options offer attractive returns while maintaining a low-risk profile. 

Frequently Asked Questions On Fixed Deposits Amid Market Crash

1. What is the best investment during a market crash?

A balanced approach works best. Distribute your investments by placing 10-30% in fixed-income assets and dividing the rest between 30 to 40% in large-cap stocks alongside the remaining percentage in mid and small-cap stocks. The market fluctuates over time, and investing on a long timeline typically results in financial growth through waiting for recovery.

2. Do I lose all my money if the stock market crashes?

A stock market crash leads to lower investment prices, but money loss only emerges when you sell low-value assets. Stockholders who maintain their investments during market recovery will see their stocks regain value.

3. Who gets the money you lose in the stock market?

Although stock prices decline during losses, the funds remain safe. The money from losses through stock price drops moves to shareholders who sold their stocks at higher values preceding the devaluation.

4. Can a stock go to zero?

When organisations become insolvent or bankrupt, their stock price will drop to zero, thus rendering the shares completely valueless. Silicon Valley Bank is an example of collapse throughout this incident.

5. What is the 3-day rule in stocks?

The 3-day rule suggests that you should let the market stabilise for three days after a substantial decline in stock price before making buy decisions. Such rules help minimise reactive behaviour toward stock prices, which results in price stabilisation.

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