What Is A Fixed Deposit? Everything You Need To Know Before Investing
Our elders usually tell us about saving our money and investing in fixed deposits (FDs). In modern times, when there is a heavy influx of information regarding various financial instruments, there is usually a question - What is a fixed deposit? How does it save money?
What Is A Fixed Deposit?
Fixed deposits are one the most famous investment instruments that help lock money with banks and financial institutions and provide some return over it. After the nationalisation of the Reserve Bank of India (RBI) in 19491, people started realising the significance of the banking industry. It further made them realise the value of investment. Thus, FDs are a popular investment instrument among the elder generations.
In the start, FDs were only offered by banks. However, now financial institutions also offer the facility. Their rates differ from each other. FDs help investors make a one-time investment, unlike recurring deposits (RD), which are also time deposits but need frequent investments.
How Does An FD Work?
The functioning of FD is very feasible to understand. Fixed deposit account is a type of term deposit, meaning it is locked for a specific period of time. Moreover, banks and financial institutions offer interest rates, which grow money annually (or as per the term specified in the scheme document).
Depositors can withdraw their funds before the tenure in some cases, but it may reduce their interest amount due to a penalty.
Let us understand with an example:
Ms. Abc kept INR 20,000/- in the XYZ bank. The bank offered FD for five years with an interest rate of 6.5%. Fixed deposit interest rates are compounded yearly.
Final Amount = Initial Amount (1+Interest Rate%) ^ Time period
Final Amount = [20,000(1+6.5%)^5]
Final Amount = INR 27,400/-
Therefore, she will earn an interest amount of nearly INR 7,400/-.
Banks and financial institutions earn interest from their loans and pay interest on deposits. The difference between them is the profit margin for banks.
What About Fixed Deposits Is So Unique?
- Tenure
As the name suggests, the period for deposit is fixed in this investment. This period differs by the type of FDs. Short-term FDs have tenure for some days to 12 months2. Long-term FDs usually have a tenure of more than one year. Investors should decide on a feasible option by ascertaining their long-term and short-term requirements.
- Safety
One of the most attractive features of FDs is the security of funds. Reserve Bank of India (RBI) is the head bank and is in charge of the banking industry in India. Further, the deposit insurance and credit guarantee corporation (DICGC) insures all deposits such as savings, fixed, current, recurring, etc.
As a depositor, you are insured upto a maximum of INR 5 lakh3 for both principal and interest amount held.
- Saving Behaviour
The predetermined term helps save money for short or long-term investments. Moreover, some institutions also provide the facility of auto-renewal of the FDs, which further helps re-invest the investment.
- Premature Withdrawal
Most institutions offer withdrawal before maturity. In such a case, some penalty is charged by reducing the interest by some days, and post-withdrawal, the fixed deposit account is closed.
For example, A 5-year FD of INR 10,000/-, offering interest at 5% simple interest per annum, is withdrawn by the depositor six months before the maturity. The depositor would get full interest for 4 years i.e. INR 2,000/-. Further, interest would be calculated for six months i.e. INR 250/-. Finally, the depositor would get the amount of INR 12,250/-.
- Mode Of Investment
FDs are investments offered by both - banks and non-banking financial companies. Usually, NBFCs offer higher interest than banks as they contain higher risk and are not secured under DICGC leading to higher risk. Due to growing digital exposure, the institutions also offer online FD facilities.
- Taxation
Depositors get deductions for the interest on specific tax-saver FDs under Section 80C4 of the Income Tax Act, 1961. Interest on FDs is taxable under “Income from other sources”. Moreover, tax is deducted on source (TDS) on such interest at 10%5 under Section 194A.
- Auto-renewal
Mostly, all institutions offer the facility of auto-renewal for fixed deposits. In this, money would be re-invested in the FD after its maturity. If the depositor has any pre-decided use of money, then one can receive the matured amount, else re-invest.
Types Of Fixed Deposits
1. Regular FDs
These are the most famous FDs which have a predetermined term. Due to this, they have higher interest rates than regular savings accounts.
2. Taxable FDs
These are specifically designed to offer tax benefits. They usually have a lock-in period of five years6 and depositors can obtain tax deductions on the interest income of such FDs under Section 80C, up to INR 1.5 lakhs (total deduction).
3. Senior citizen FDs
Senior citizens usually seek a stable income source in their old age, due to lack of fixed incomes like salary. Thus, FDs provide a feasible option and higher interest rates than regular FDs. It is to support the needs of senior citizens.
4. NBFC FDs
Companies have varied options for investment, and to balance, fixed deposit accounts offer safety and balance the risk in the portfolio. Institutions offer corporate fixed deposits, which have potential interest rates.
5. Flexi FDs
It is a combination of demand deposits and fixed deposits. Depositors will get liquidity of savings and current accounts, along with the fixed deposits interest features. Also, some banks offer the facility of ‘auto-sweep’ in which the surplus of savings account is transferred to fixed deposit, after the customer’s intimation.
What Are Bank Fixed Deposit Eligibility Criteria?
Investment in FDs are reasonable and a good start for investors seeking safe returns. A depositor should be of age 18 or more. If not, then children above 10 years can open a fixed deposit account with their natural or legal guardian. The minimum investment limit changes as per bank norms. So, any individual can make this investment after properly understanding different options and personal needs.
Conclusion
Fixed deposits (FDs) have always been an attractive investment in India. Investing only in the savings or current account can keep the money idle. However, the FDs have the power to grow money with a stable one-time investment.
It has options for premature liquidity, good interest, safety, investment modes, etc., which will help depositors easily save funds for the short or long term. Moreover, various types of FDs can be opted for based on the suitability of depositors. Depositors should read the scheme document thoroughly before investing.
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Frequently Asked Questions On Fixed Deposits
1. Can Alternative Investment provide better returns than FDs?
Alternative investments have a different rationale than traditional options like fixed deposits and stocks. They have market exposure and provide potential returns. However, they also come with higher market risk when compared to FDs. Investing in such options is not very difficult because of technological advancements. Grip Invest is a leading platform in alternative investments.
2. What is Better, FD or RD?
Fixed deposit accounts (FDs) and recurring deposit accounts (RDs) are term deposits, meaning they are confined to a specific term for investment. The main difference between them is regarding the frequency of this investment. In FDs, depositors would invest once with their surplus corpus, and it would grow as per the selection of long-term or short-term plans. On the other hand, RDs are systematic fixed investments made at every equal interval. The better option between these two can be opted as per the depositor’s corpus availability or requirement.
3. What is the Disadvantage of FD?
The fixed tenure of FD may not be suitable for some depositors. Moreover, if the investment is removed early, one loses potential interest. FDs are not exposed to the market and have lower returns than other investment options. It can pose a risk of inefficiency in combating inflation. So, fixed deposits have different disadvantages despite being the most popular investment.
References
1. Reserve Bank of India <https://rbi.org.in/history/Brief_Chro1935to1949.html>
2. The Times Of India <https://timesofindia.indiatimes.com/business/financial-literacy/savings/short-term-fixed-deposits-earn-fd-rates-up-to-8-75-top-banks-for-highest-interest-rates-for-less-than-1-year-tenure/articleshow/109562793.cms>
3. Reserve Bank of India <https://www.rbi.org.in/commonperson/english/Scripts/FAQs.aspx?Id=272>
4. Income Tax Department, Government of India <https://www.incometax.gov.in/iec/foportal/sites/default/files/2023-05/CBDT__e-Filing_ITR-1_Validation%20Rules_Version%201.0.pdf#page=9>
5. Income Tax Department, Government of India <https://incometaxindia.gov.in/Pages/faqs.aspx?k=FAQs+on+Tax+Deducted+at+Source+(TDS)>
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