Investing in Fixed Deposits: Understanding the Risks & Maximizing Returns

Investing in Fixed Deposits : Fixed deposits (FDs) are often seen as a secure way to invest money. Many people trust FDs as a way to safeguard their future and that of their families.
However, there are several risks associated with FD investments that could potentially lead to financial losses rather than benefits. Before committing to an FD, it's crucial to understand these risks.
In this article, we highlight five key things you need to know before investing in a fixed deposit.
Returns May Be Lower on Fixed Deposits
One of the major drawbacks of investing in FDs is the risk of low returns, especially during times of falling interest rates. When the central bank reduces interest rates, banks often follow suit and lower their FD rates as well.
This means you may earn less on your investment, which might not keep up with inflation. However, some banks do offer higher returns, so choosing the right bank can make a significant difference in your FD’s profitability. It is always a good idea to compare interest rates across various banks before making a decision.
Insurance Cover on Fixed Deposits
A key advantage of FDs is the insurance coverage provided by banks. When you invest in an FD, the deposit is typically insured, offering protection against any potential bank defaults.
To maximize this coverage, it’s recommended that you distribute your investments across multiple banks. This strategy can help you minimize risk and ensure better insurance coverage for your deposits.
Currently, small finance banks are offering higher interest rates on FDs, which could be a better option compared to public or private banks.
For instance, banks like Surya and Unity offer up to 8.25% interest on FDs with a tenure of five years or more, which is considered quite attractive.
Be Aware of Liquidity and Tenure
When investing in FDs, you must pay attention to the liquidity and duration of the deposit. While some banks allow you to withdraw your money before the FD matures, others impose penalties for early withdrawal.
In case of emergencies, withdrawing an FD early could result in a fee of up to 1% of the interest, which is typically lower than the original interest rate.
The penalty amount can vary based on the time left in the FD’s term. It's important to know the rules regarding early withdrawals and liquidity before you invest.
Think Carefully Before Making an FD Investment
Before investing in an FD, don't focus solely on the interest rates. It's crucial to understand the potential penalties if you need to break your FD before maturity.
The interest on the withdrawn FD may be calculated according to the bank’s terms, and it might be lower than what you initially expected
. Understanding the interest calculation process and the bank’s conditions is important to avoid any unpleasant surprises later on. Properly evaluating these factors will ensure that you make an informed investment decision.
Tax Benefits with Tax-Saving FDs
Tax-saving FDs are a popular option for investors looking to reduce their tax liabilities. By investing in tax-saving FDs, you can claim tax deductions of up to ₹1.5 lakh in a financial year under Section 80C of the Income Tax Act.
These FDs come with a lock-in period of five years, meaning you cannot withdraw the funds before this period. However, the interest earned on tax-saving FDs is still subject to tax, based on your income tax slab, just like regular FDs.
FD Insurance in Case of Bank Default
Fixed deposits in banks, along with savings and current accounts, are insured up to ₹5 lakh per depositor. This insurance coverage provides protection in case of a bank default. T
he Deposit Insurance and Credit Guarantee Corporation (DICGC) ensures that the invested amount, including the interest, is covered in case the bank fails. This helps mitigate the risk associated with banking institutions going bankrupt.
Benefits for Senior Citizens
Senior citizens enjoy additional benefits on their FD investments. Under Section 80TTB of the Income Tax Act, they are eligible for tax exemptions on interest income up to ₹50,000 from banks and post offices. This benefit is exclusive to senior citizens and is aimed at providing them with some relief from tax burdens.
Investment Options Beyond Fixed Deposits
While FDs are considered safe, they may not always provide returns that outpace inflation. Investors who fall in higher tax brackets may find better returns through other investment options like Public Provident Fund (PPF), National Savings Certificates (NSC), or Sukanya Samriddhi Yojana.
These investment options not only provide attractive returns but also allow for tax savings under Section 80C.
For those willing to take more risks for higher returns, Equity Linked Savings Schemes (ELSS) could be a viable option.
These schemes offer a lock-in period of just three years, which is the shortest among tax-saving investment options, making them ideal for risk-takers looking for higher returns.
Leveraging FD for Secured Credit Cards and Overdraft Facilities
Many banks offer secured credit cards or overdraft facilities against FDs. These options can be particularly useful in financial emergencies. With an overdraft, you can borrow money based on your FD, and the interest is charged only on the amount borrowed.
The remaining balance of your FD continues to earn interest. Moreover, using an FD to secure a credit card can help improve your credit score over time, as the bank reports your transactions to the credit bureaus.
Tax Deducted at Source (TDS) on FD Interest
TDS is deducted on the interest earned from fixed deposits. The rate of TDS is 10% if you have a PAN card, and 20% if you don't. However, TDS is not a final tax; you are still required to declare your total income and pay the remaining tax according to your tax slab.
If your annual interest income is less than ₹40,000, TDS is not deducted, but you must adjust it during tax filing to ensure proper tax payment.
Conclusion: Choosing the Right FD
As interest rates on FDs may decrease in the coming months, it's essential to select the FD duration based on your financial needs and goals.
If you opt for long-term FDs, ensure that you are comfortable with the lack of liquidity, meaning your funds will be locked in for the chosen period.
Moreover, if you qualify for a loan or credit card against your FD, it can help improve your credit score without the need to break the FD.
FDs, while generally secure, require careful consideration of various factors like liquidity, interest rates, and penalties for early withdrawal.
By choosing the right FD and understanding its terms, you can ensure that your investment works in your favor.