You can open a Fixed Deposit for as many days as 7 days to 10 years. Depending on your need for liquidity, you can choose to hold a Fixed Deposit in a bank or NBFC that offers the best interest rates on FD.
The objective of investing in a Fixed Deposit is to earn interest income. Interest on Fixed Deposits varies across banks and NBFCs and also depends on the tenure of the deposit. While short-term deposits with a maturity of less than a year carry a higher interest rate than that of a 10-year deposit, interest cycle changes and macroeconomic factors like inflation can have a direct bearing on the returns.
Long-term FD v/s Short-term FD
You need savings so that you can be privy to funds when you need them. In such cases, short term deposits work well and give you the dual benefits of returns as well as liquidity. Long term Fixed Deposit, on the other hand, have a longer lock-in period. Breaking the same, which amounts to pre-closure, will attract penalty, thus minimising your returns from the Fixed Deposit.
Hence, it’s recommended that you ladder your Fixed Deposit investments across a time frame so that you earn maximum interest as well as have access to funds when you need them the most.
Pointers in Favour of Investing in Long Term Fixed Deposits
- Mitigates Reinvestment Risk
If you don’t have an urgent need of funds, you can reinvest the Fixed Deposit upon maturity. If you opted for a short-term Fixed Deposit, and the interest rates have fallen, then you have to compromise on the rate of interest. On the other hand, if you had opted to hold a long-term Fixed Deposit, you will not have to face the reinvestment risk
- Cushions your Interest Cycles
The rate of interest offered by banks and NBFCs on Fixed Deposits is governed by many factors, which include the rate at which the financial institution lends money, RBI guidelines, inflation, and general trend in the economy. In fact, compared to the past couple of years, where Fixed Deposits held for 5 years earned you close to 10% interest, currently for the same duration, you earn just about 8%.
To cushion the blow against the fluctuating interest cycles, long term Fixed Deposits are the best option to maximise your returns. As per the ongoing trend, interest rates are going south and with the downward slide likely to continue, investing in long term Fixed Deposit is the best bet.
- RBI Policies
Banks and NBFCs have to adhere to RBI guidelines with respect to their functioning. In a bid to ensure liquidity in the economy, the RBI alters the CRR (Cash Reserve Ratio- the percentage of funds banks have to maintain with the RBI). A tight cash flow situation will result in lower interest rates on Fixed Deposits.
In addition, if the repo rate is also lowered, FD interest rates are bound to fall. Since these factors are beyond an individual’s control, you can safeguard yourself by locking in your savings in long-term Fixed Deposits at a higher interest rate.
- Tax Benefits
The interest you earn on Fixed Deposits is entirely taxable. If you fall in the highest tax bracket you end up paying tax on interest at the full rate. Further, FD interest is liable to TDS as well. If the interest earned on your Fixed Deposit is more than Rs.10,000 in a particular financial year, tax would be deducted at source by the bank or NBFC.
If you are keen to save tax and thereby maximise your savings from the Fixed Deposit investment, the best bet would be a long-term tax saving Fixed Deposit. Such deposits have a lock-in period of 5 years, thus assuring you greater returns. Further, investment in such deposits qualify for a deduction from your gross total income under section 80C of the Income Tax Act.
Long-term Fixed Deposit can Give Negative Returns
While it can be agreed to a great extent that Fixed Deposits are indeed a safe investment option with assured returns. But, does the FD interest factor the tax component and inflation? By now, you are well aware that FD interest is taxable. You can use Fd calculator to determine earn interest on FD.
So, if you calculate the post-tax return on your Fixed Deposit, it will definitely be less that the rate of interest that appears on your Fixed Deposit receipt. What banks advertise to attract deposits is the pre-tax interest. Think over, what is your real rate of return? Is there an escape from inflation? As the purchasing power of money erodes, in the long term, on a Fixed Deposit held at 8% interest, a double digit inflation scenario can actually give you negative returns.
To conclude, Fixed Deposits are indeed a preferred investment option as they preserve the principal and offer a stable and guaranteed return. In the long run, they hedge against interest cycles and do not expose you to reinvestment risk. As a smart investor, you need to also factor the effects of tax and inflation to determine the real rate of return and invest accordingly choosing a tenure that maximises your return from the Fixed Deposit.