Most of us have heard our parents talk about parking their money into a fixed deposit and earning interest. Some of us may have even seen some of the money invested by our parents mature over a period of time and yield more. Though this financial instrument has been around for a long period of time, some of us are still unaware of the advantages and disadvantages of fixed deposits. Also, with the rising interest in liquid mutual funds, the demand for fixed deposits is slowly waning. But is returns the only feature that makes fixed deposit a safe investment instrument? Let’s read to know more.

What is a fixed deposit?

To begin the discussion, it is important to the fixed deposit meaning. Fixed deposits are financial instruments offered by banks and non-banking financial companies (NBFCs) in which an individual can invest a sum of money for a fixed period of time and earn a fixed rate of interest. As compared to market related financial instruments, a fixed deposit is considered to be a safe investment option as the rate of interest provided by the bank is fixed. Some of the features of fixed deposits are as follows:

• Fixed deposits can be issued by banks as well as corporate
• This investment option provides a fixed rate of return
• The return varies on the tenure of investment as selected by the investor
• Higher the timeframe, higher will be the return offered and vice versa
• The risk on this investment option is nearly the least among all the asset classes

While investing in a fixed deposit, one must remember that the interest on the principal amount is paid monthly or quarterly and not yearly. Also, for those who choose to reinvest their interest, the rate of retun would be 8.24% in a year. Hence, if the amount deposited is Rs 10,000 for a period of 1 year at 8% interest rate, the total sum on maturity will be Rs 10,824.

Types of fixed deposits

Indian banks offer a variety of fixed deposit options with specific interest rates and tenures. The standard fixed deposit is the simplest form in which the time and interest rate is fixed.

The second type would be the cumulative fixed deposit in which the interest is not paid monthly but only at the time of maturity. The third type is the flexi fixed deposit which allows you to withdraw a part of the sum deposited while interest is accrued on the rest of the principal. The most popular type is the tax saving fixed deposit which has a lock-in period for 3 years and above during which you cannot withdraw the amount. One can claim tax exemption for this kind of deposit under Section 80C of the Income Tax Act. However, one should always remember that the interest gained from fixed deposits is taxable.

There are a number of advantages of fixed deposit. Primary among these is the fact that the rate of interest is not market linked and will not fluctuate. Hence, fixed deposits are considered a safe investment option. No matter how bearish the market becomes, the banks will pay the fixed rate of interest to the individual. Apart from these, some other advantages of a fixed deposit are:

Loan option: One can take a loan against the fixed deposit for a lower rate of interest.

Regular interest payout: The interest paid out to the depositor is not either monthly or quarterly. This amount can be withdrawn or reinvestment as per the depositors choice.

Tax benefit – As comapred to liquid mutual funds, fixed deposit has the option of being a tax saver. The Government of India gives tax exemption benefits for some deposits which are 3 years and above. 

Good rate of return: Most of the banks offer interest rate above 7% for fixed deposits. This is much higher than the 4% interest rate offered by banks for parking your money in a savings deposit. Some of the top Indian banks and their deposit rates are listed below:

While FDs are lucrative, there are some disadvantages of fixed deposits as well. These are:

Tax on interest earned - The interest accrued from fixed deposits is considered as an income for the year and is taxable.

Liquidity woes - Not all fixed deposits can be withdrawn at any given time. For those with tax benefits, there is a lock-in period and the money cannot be withdrawn during this period. For others, banks give a lower rate of interest if the money is withdrawn before maturity.

Lower rate – As compared to liquid mutual funds, fixed deposits are low risk assets but also less dynamic. Rates are fixed by the banks and do not go up when markets are performing well.

Despite all disadvantages, fixed deposits are a good investment option and a must add to your investment portfolio.