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How to invest in fixed deposits

For most investors, safety of the principal invested remains the most important feature pushing other factors such post-tax return to the back ground.

, ET Online|
Updated: Nov 02, 2018, 11.57 AM IST
The post-tax return and the real return after adjusting of inflation is low in FDs thus defeating the purpose of wealth creation.
Many invest in bank fixed deposits (FDs) and treat it as the most secure place to park their savings. This is largely because when it comes to investing, for most investors, safety of the principal invested remains the most important feature pushing other factors such as interest rate, liquidity, and post-tax return to the back ground.

However, FDs should largely be viewed as a place to park money with the objective of preserving the capital rather than a means to create long-term wealth. The post-tax return and the real return after adjusting of inflation is low in them thus defeating the purpose of wealth creation.

Now, if you still want to invest in a bank FD, here are a few things you should consider while investing in them.

1. Interest rates
The interest rate will vary across banks and across tenures. Once deposit is made, the rate of interest will remain fixed till maturity. New banks and even some small finance banks may offer higher rate of interest compared to other commercial banks. All banks provide an additional interest to senior citizens irrespective of the tenure. The rate of interest, tenure, and amount invested and the maturity amount will get printed on the deposit certificate called FD Advice. At the time of renewal, the interest rate prevalent then will apply unless the deposit is withdrawn.

2. Choice of tenure
The deposits are available for a short term of 7 days to a tenure going up to 10 years. A better way to manage interest rate risk and provide some liquidity to funds as well is to 'ladder' one's deposits across tenure. So, instead of, say, locking in funds in a 1-year deposit, divide it across 1-3-5 year FDs. When the shortest-term FD matures, renew it for the longest duration and continue the process as and when the various FDs get matured. While doing so, ensure that your regular income need is met, and deposits are spread across various maturities and across banks too.

In addition, there could be higher rate of interest on specific tenure. For example, a bank may offer a 270 days deposit or a 414 days FD with a slightly higher rate. Keep an eye on such offerings to gain an extra buck if the tenure suits your requirements.

Importantly, if you wish to save tax under section 80C by investing in bank FD, then you will have to specifically choose the 5-year tax-saving FD, the maximum investment in which is capped at Rs 1.5 lakh per annum.

3. Choosing frequency of interest payments
Depending on one's need, one may choose to opt for monthly, quarterly, half-yearly or annual interest payments. Alternatively, if someone doesn't need regular income, the reinvestment mode can be opted for. In the latter, interest gets reinvested after quarterly compounding and is paid on maturity along with the principal amount invested.

4. Premature withdrawal of deposit
In the event of the fixed deposit being closed before completing the original term, interest will be paid at the rate applicable on the date of deposit for the period for which the deposit has remained with the bank. The deposit may be subject to a penal rate of interest as prescribed by the bank on the date of deposit. For such premature withdrawals, including sweep-ins and partial withdrawals, most banks levy a penalty of 1 percent, on the applicable rate. However, in all banks, penalty for premature withdrawal is not applicable for FDs booked for a tenor of 7-14 days.

5. Taxability
Interest rate earned on a bank FD is fully taxable. For someone in the highest income slab, a 7.25 percent return translates into a 5 percent post-tax return. Here is how the taxation works: on a bank FD of 7.5 percent, the post-tax return for the 5 percent, 20 percent and 30 percent tax brackets works out to be 7 percent, 5.94 percent and 5.16 percent, respectively. Also, for a bank FD, interest earned (across branches) over Rs 10,000 a year (unless form 15 G/H is submitted) will attract TDS of 10 percent on interest income. So, keep an eye on post-tax return before you invest in an FD.

6. Safety
Bank deposits continue to be insured under the Deposit Insurance and Credit Guarantee Corporation (DICGC). Under the DICGC rules, each depositor in a bank ( across all branches ) is insured up to a maximum of Rs 1 lakh for both principal and interest amount held in the same capacity and same right. However, there is an implicit guarantee on the deposits at least with the mainline commercial banks as the government won't allow them to fail as seen in the past.

7. Mode of investment
One may invest in a fixed deposit through various modes such as Internet banking or by visiting a nearby bank branch. Some banks also allow one to invest in FDs through ATMs and phone banking channels.

What you should do
Bank FDs suit ultra-conservative investors as they do not settle for anything other than fixed and assured return with high safety. Also, retired investors, who need fixed, assured and regular income, rely heavily on bank FDs. While safety and fixed returns go well with retirees, the ease of operation also makes it a reliable avenue.

Additionally, bank FDs may also be used by all to park emergency funds that can be accessed in few days, especially the sweep-in deposits. Such deposits along with investments in short-term mutual funds can be a part of one's emergency fund. Remember, bank FDs represent the debt potion of one's asset allocation and should be sparingly used to meet one's needs.

Also Read

State Bank of India cuts interest rates on savings accounts, fixed deposits

SBI cuts MCLR and fixed deposit rates across all tenors

SBI reduces interest rate on fixed deposits across all maturities

Perpetual bonds are offering higher interest rates than fixed deposits: Should you invest?

Gold vs fixed deposits: Where should you invest?

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