Points To Remember Before Investing In Fixed Deposit
So lately you have been earning a lot and then one fine Sunday afternoon, the granddaddy of all financial advices visits you in a heavy and deep voice – ‘You should think of future and save. Go and invest in Fixed Deposits’. This is one piece of financial advice that almost every single one of us have received from our parents or grandparents or some elderly well-wisher who shows up once every one or two years usually if there is something he or she needs something or there is some occasion or simply because the person loves to believe that he or she is some kind of ‘Jack of all trades’ when it comes to future financial planning.
Weirdly enough, we the younger generation, have this uncanny knack of actually committing to this Fixed Deposits advice. We know because we did the same and many of our known associates (friends or colleagues) have also done the same. We really don’t think much when it comes for FD simply because our parents and grandparents did that and they indeed received more than what they deposited. We just tend to act on what we see and we have this notion that:
- FD deposits are absolutely safe.
- FD deposits always work because they are time-tested investment vehicles.
Really? Think again!
Let us give you two scenarios:
- The bank where you have your fixed deposit goes bankrupt. India’s context we can cite the example of UTI bank. In America’s context we can cite the example of Lehman Brothers.
- A situation like the Great Depression of 1930 repeats itself.
Okay, here is one more scenario:
- The bank took your money and invested the same in market, especially in US companies. What if the US economy collapses and US dollar loses its status of Reserve Currency?
Do you still think FDs are absolutely safe? Actually you may argue that these things don’t happen daily. You are right! But, they happen! No one can guarantee that such a situation will not arise tomorrow morning. Can you? Well, we believe that we have your attention now.
Honestly, we are not here to deter you from investing in fixed deposits. Invest wherever you want but before you decide to go with fixed deposits, we request you to carefully go through the following points and imprint them in your mind:
- Fixed deposits are not absolutely safe: If you are thinking of corporate fixed deposits, they are never safe. There is a nice term for explaining corporate fixed deposits – ‘UNSECURED LOANS’. Simply put, there is no guarantee that you will get back your money. Talking of banks, their FDs are partially secured. There is a body known as DICGC or Deposit Insurance and Credit Guarantee Corporation, which promises to refund maximum of up to INR 100,000 for a single FD with a bank in case of some mishap. This means that if you have an FD of INR 200,000 and if a mishap happens, you can get back only INR 100,000. The remaining INR 100,000 will be lost. So, the best thing to do is to open one FD account each in different banks and invest no more than INR 100,000 in each account. This way, in the event of a mishap, your money remains secured. However, in case of a complete economic meltdown on a global scale (as that of the Great Depression of 1930), even this partial guarantee is lost.
- Diversify investment: Some people happen to get it wrong. A fixed deposit is called fixed because of the fixed tenure and not because of the fixed interest. Interest rates for FDs change every few years. So, play wise! In case you have say about INR 500,000 to invest, create 5 different FD accounts in 5 different banks and make sure that each FD has a different tenure. For example one account may have 1-year tenure. The other one may have 2-year tenure and so on. Now, when the account with lowest tenure matures, take the money and check out whether the interest rates have changed or not. If the interest rate has increased, reinvest again. If the interest has not changed, you can reinvest in FD or think of reinvesting in other financial instruments offering higher interest rates or greater flexibility or both. If the interest rates have fallen below the previous level, just invest somewhere else with greater flexibility. Also, the fun part is that every year there will be one FD maturing, providing you with some liquidity in case you need.
- Premature withdrawal penalty: If you happen to withdraw your investment before the maturity of the investment, two things will happen:
- There are not tax savings on earnings: Okay, the moment you invest in FD, your investment amount becomes tax-free but what about the interest earnings? The earnings will be subjected to Tax Deduction at Source or TDS. The bank or the corporate company will actually deduct TDS and then give you the remaining interest earning provided that the total interest earned in a given year is greater than INR 10,000. Now, if you are thinking that TDS is all you have to pay, you are wrong. In case you are actually in a high-income bracket (which is usually defined as INR 5 lakhs per year), whatever interest you earn post TDS deduction from your FD actually becomes your income and since you are in high income bracket, you will have to pay more taxes.
- FD interest earning from your child’s or spouse’s FD account is your income: Assuming that your wife is a housewife or your husband is not earning, you can actually create an FD in her or his name. The money you invest is tax-free because it will be seen as a gift. However, the interest that will be earned on that deposit will not only be subject to TDS but the post-deduction earning will be counted as your income and hence, subject to income tax. The same is true for your child’s FD.
- Interest rates remain locked for a FD: Once an FD account has been created at a given interest rate, that interest is going to continue till maturity. However, in the mean time, interest rates can go down or go up. So, any new FD will be made using new interest rates not the old one already applied to the existing FD.
- You can reclaim TDS deductions (not always): FD interest earnings are always handed over after TDS deductions provided the interest earnings have exceeded 10,000 rupees in a year. But assuming that if TDS was not deducted and your interest earnings plus your existing income is still below basic taxation limits, you can use form 15G and reclaim the deducted amount. For senior citizens, it will form 15H.
That’s pretty much all the important points about fixed deposits that you should always remember in order to play safe.