Fixed deposits, or FDs, have been a tried and tested instrument in India to preserve and grow wealth at moderate rates. In the post-COVID era, when market volatility is high and may often be unexpected, creating a well-diversified investment portfolio with FDs can be very useful. This is because the FDs serve as a cornerstone in the portfolio, offering stability and security.
In this context, let us go over some of the distinct advantages, as well as certain limitations of fixed deposits.
Overall, the guarantee of the safety of the deposit, the guaranteed fixed returns and those returns being higher than the average savings deposits are some of the most attractive features of the fixed deposit.
FDs provide a stable, predictable return on investment, shielded from market volatility. The principal amount remains secure, offering peace of mind to risk-averse investors.
With pre-determined interest rates, FDs assure fixed returns at maturity. This predictability makes them an attractive option for planning future cash flows.
Including FDs in a portfolio adds balance by offsetting riskier investments like stocks or mutual funds. This diversification hedges against market fluctuations.
While FDs have a fixed tenure, many financial institutions offer premature withdrawal options or loans against FDs, ensuring access to funds in times of need.
FDs offer flexible tenure options, ranging from a few months to several years. Institutions also provide different interest payout frequencies, catering to diverse financial needs. You can thus arrange your FDs with varied interests and maturities in a way that matches the various financial goals or requirements that you may have from time to time in the coming years.
Under Section 80C of the Income Tax Act, investments in certain FDs can qualify for tax deductions, thereby reducing the tax burden on investors.
FD interest rates are fixed at the time of investment. In a fluctuating market, this fixed rate might not keep pace with inflation, potentially impacting real returns.
Once invested, the funds are locked in for a predetermined tenure. Premature withdrawals might incur penalties or reduced interest rates, affecting the overall returns.
While FDs offer security, their conservative nature might lead to missed opportunities for higher returns available through more dynamic investment avenues like equities or real estate.
Your personal financial strategy depends on the level of returns you need, the timeline of your investments and the amount of risk you are willing to face among other factors. Let us review the utility of an FD based on some key contexts.
Fixed deposits are suited for those who:
The principal and the interest of the FD are both guaranteed by the bank. You can therefore look at an FD as a low-risk instrument and use it to act as a balancing force or an anchor in your portfolio. The low risk of the FD can then offset the risk from the high-risk instruments in your portfolio such as equity or equity funds.
However, there are still certain risks associated with FDs:
Stocks and derivatives are some of the most risky assets available in the market. Therefore, if you are new to personal finance, you should keep stock and derivatives trading to a minimum. However, if you want returns beyond 10% to 15% then you may consider investing or trading in stocks and derivatives. Compared to them, fixed deposits are low-risk investment tools that give moderate returns of 5% to 8%, regardless of market conditions.
Mutual funds are of various types. A fund may be investing in stocks, bonds, or commodities. Based on the proportion of different assets that the funds invest in, the risk and returns of the fund may vary. Therefore, you need to evaluate the overall risk and return associated with the investment in order to understand which one you should invest in and in what proportion. In such a situation, you may take the help of an FD calculator and a mutual fund returns calculator to assess the returns in the long run.
However, there are certain advantages that an FD has over a mutual fund.
Both FDs and mutual funds may or may not have a lock-in period and penalties for early withdrawals.
Bonds may offer guaranteed returns at a fixed rate if they are fixed-rate bonds. The rate of return may vary if it is a floating-rate bond. This is in contrast with FDs which have a fixed rate of return.
However, bonds not only give returns from the interest paid, but also offer capital gains from an increase in the price of the bonds. However, they also run the risk of depreciation in value if the interest rates in the market increase too much. A fixed deposit does not have this issue as they cannot be bought or sold in a market.
Fixed deposits, pension funds and insurance are popular investment avenues. But while both pension funds and insurance are meant to help you under a very specific set of circumstances, such as health issue or old age, an FD can be redeemed whenever you want, subject to any lock-in periods.
When it comes to diversifying beyond FDs, it is best that you take a dynamic approach. This means, in your initial years, you can place a moderate portion of your investment in an FD and use the rest to earn high returns from stocks and derivatives and learn more about various investment strategies. Also, you can invest in a pension fund and insurance at this stage.
Over time, as your early investments pay off, you may consider transferring the money to more and more FDs, especially if you are suspecting a bear market. Finally when your pension fund becomes redeemable, you can choose to then invest the redeemed money and a larger chunk of your portfolio in risk-free instruments like FDs.
Fixed deposits, with their stability and predictability, play a pivotal role in a diversified investment portfolio. While their limitations must be acknowledged, the security and guaranteed returns they offer make them an essential component in financial planning.
Enjoy Zero Brokerage on Equity Delivery
Join our 1.75 Cr+ happy customers
Enjoy Zero Brokerage on