The Ultimate Guide to Investing in an FD (Fixed Deposit)

A Fixed Deposit (FD) is one of the most popular investment options in India. It is a low-risk investment option that offers a fixed rate of return. With FDs, you can invest your money and earn a fixed rate of interest for a fixed period. These are offered by banks and other financial institutions for varying tenures.

In this blog, we will discuss what FDs are, their benefits, types, and factors to consider before investing in them. Whether you are a new investor or a seasoned one, this guide will help you make informed decisions when it comes to investing in fixed deposits.

What is FD (Fixed Deposit)?

A fixed deposit is a financial instrument where an investor deposits a lump sum amount of money for a fixed period of time with a financial institution like a bank or a non-banking financial company (NBFC).

The deposited money earns a fixed interest rate that is higher than a regular savings account. The fixed deposit interest rate remains the same throughout the term of the deposit. At maturity, the investor gets back the principal amount along with the interest earned.

Types of FDs (Fixed Deposits)

There are various types of Fixed Deposits in India, including:

Cumulative Fixed Deposits: In this type, the interest is compounded and paid along with the principal amount at the end of the investment tenure.

Non-cumulative Fixed Deposits: In this type, the interest is paid at regular intervals – monthly, quarterly, half-yearly or yearly – as chosen by the investor. The principal amount is paid at the end of the investment tenure.

Flexi Fixed Deposits: This type of fixed deposit allows investors to withdraw a part of the deposit amount before maturity without incurring a penalty. The interest is paid at regular intervals, and the remaining amount continues to earn interest till maturity.

Tax-saving Fixed Deposits: These are special fixed deposits offered by banks that come with a lock-in period of five years and offer tax benefits under Section 80C of the Income Tax Act. The interest earned on these deposits is also taxable.

Sweep-in fixed deposits: These fixed deposits allow you to link your savings account and fixed deposit account, allowing you to earn higher interest rates while maintaining liquidity.

Senior Citizen fixed deposits: These are similar to regular fixed deposits, but the senior citizen FD rates are usually higher for senior citizens.

Calculation of Interest on FD (Fixed Deposit)

The calculation of interest on FDs depends on three factors:

Amount invested
Rate of interest
Duration of the fixed deposit

The formula for calculating interest on an FD = Amount Invested x Interest Rate x (Duration/ 12 months)

Let’s understand how interest is calculated on an FD with the help of an example.

Suppose John is investing ₹30,000 in a cumulative FD for three years at an interest rate of 6% per annum. When the tenure ends, the FD will have a maturity value of ₹35,730.

Year	Principal Amount	Interest Earned (at 6% p.a.)	Maturity Value
1	₹30,000	₹1800	₹31,800
2	₹31,800	₹1908	₹33,708
3	₹33,708	₹2022	₹35,730

Eligibility for Fixed Deposits (FDs)

You can easily invest in an FD if you are:

Indian residents
NRI
Minors
Senior Citizens
Partnership Firms
Companies
Societies and Clubs
Sole proprietorship
Individuals or Joint Investors

What are the Documents Required to Invest in an FD?

To invest in an FD, the following documents are generally required:

Identity proof (such as an Aadhaar card, PAN card, passport, or driving license)
Address proof (such as an Aadhaar card, passport, utility bill, or bank statement)
Passport-size photographs
In the case of senior citizens, age proof may be required
In the case of a joint account, the documents of all account holders are required
It’s important to check with the specific bank or financial institution regarding their specific requirements.

Benefits of Investing in an FD (Fixed Deposit)

1) Guaranteed Returns: The best thing about investing in an FD is that you know the amount that you are going to receive after the completion of your tenure.

2) Better Interest Rates: Another factor you should consider is that FD interest rates are higher than normal savings accounts. In fact, FDs provide special interest rates for senior citizens.

3) Hassle-free Investment: It is quite easy to invest in an FD. All you need to do is visit your bank, fill out an application form, and submit it. That’s it! However, some banks offer online services as well. Hence, you won’t need to visit a bank to invest in an FD.

4) Easy to Monitor: Since the FD interest rates do not fluctuate, you do not need to monitor their performance continuously.

Apart from this, FD investment allows you to withdraw your money whenever you want. However, you will be charged a penalty for doing so.

We hope that now you are aware of an FD’s benefits. But as we know, everything has two sides, i.e., the benefits and the disadvantages. So, without further ado, let’s check out the disadvantages of fixed deposits.

Disadvantages of Investing Fixed Deposits

1) Reducing Interest Rates: Fixed deposit rates are better than a typical savings account, but these interest rates are not in line with inflation.

Many people show disinterest in FDs because, even after investing in a long-term FD, they don’t earn as much as they should.

2) Locked-in Funds: If you are putting money into an FD, you should get the lump sum amount only after the completion of your tenure. Consequently, you can not easily convert your FD into cash.

3) No Tax Benefit: The interest earned on an FD is added to the holder’s taxable income. This means that there will be deductions on any interest earned by you.

4) Penalty: If you prematurely withdraw the fixed deposits, you will have to pay the penalty.

5) Fixed Interest Rate: The interest rate on the FD will remain the same till the completion of the tenure. So, even if the Fixed Deposit rates have increased, the bank will not pay any additional interest to you.

How to Invest in a Fixed Deposit (FD)?

You can invest in an FD by following these simple steps:

1) Check and compare interest rates

Different financial institutions offer different interest rates on FDs. Hence, carefully check and compare the interest rates offered by these financial institutions before making any investment decision.

2) Pick suitable deposit tenure

FDs typically have a term of between seven days to ten years. Therefore, you should choose a reasonable deposit tenure on the basis of your needs.

Moreover, financial experts frequently advise laddering FD across various tenures to spread out interest rate-related risks and improve liquidity.

3) Choose interest payout frequency

Once you finalize the tenure, you may choose the frequency at which you want to receive interest payouts. Usually, you have the following options to receive interest payouts:

Monthly
Quarterly
Semi-annually
Annually.

If you don’t want to receive interest immediately, you can also choose the reinvestment FD mode. This facility will enable you to reinvest your earnings once they have been compounded quarterly and will be paid out with the principal invested when it matures.

4) Choose a mode of deposit

Once you decide on the interest payout frequency, you can move on to the next step, i.e., choosing a mode of deposit.

Most financial institutions allow FD holders to deposit funds either online through Internet banking or in person by visiting the nearest branch. Once you decide on your mode of deposit, you can move on to submit an FD application and then make an investment in a plan.

What is the Impact of Investing in a Fixed Deposit (FD) on a Financial Portfolio?

Investing in fixed deposits (FDs) can have a significant impact on a financial portfolio. While FDs offer stability, they also offer relatively low returns compared to other investment options such as equities or mutual funds. Thus, investing a large portion of the portfolio in FDs may result in lower overall returns.

Additionally, FDs have a fixed tenure and withdrawing funds before maturity may result in penalties. Therefore, it is important to consider the impact of investing in FDs on the overall financial portfolio and diversify investments across various asset classes for optimal returns and risk management.

Factors to Consider Before Investing in an FD (Fixed Deposit)

Before investing in fixed deposits (FDs), there are several factors to consider, including:

Inflation: Inflation is the rate at which the cost of living increases. If the inflation rate is higher than the FD rates, the real rate of return will be negative, meaning the value of your investment will decrease in real terms.

Tax rates: The interest earned on FDs is taxable as per the income tax slab of the investor. Therefore, investors should consider the tax rates while investing in FDs.

Interest rates: The FD interest rates vary depending on the duration of the investment. Longer investment tenures tend to offer higher interest rates. Therefore, investors should consider the interest rates before investing in FDs.

Investment tenure: FDs come with a fixed tenure, and withdrawing the investment before maturity may result in a penalty. Therefore, investors should consider the investment tenure before investing in FDs.

Investment amount: FDs have a minimum investment amount, and investors should consider their financial goals and investment amount before investing in FDs.

Taxation on FDs

In India, tax on FD interest is based on the investor’s tax bracket and investment tenure. Interest earned on FDs is added to the investor’s total income and taxed accordingly.

For FDs with a tenure of fewer than five years, the tax deduction at source (TDS) is applicable if the interest income exceeds Rs. 40,000 in a financial year. For senior citizens, the TDS limit is Rs. 50,000.

Therefore, before investing in FDs, make sure that you consider the taxation aspect and choose a tenure that aligns with your tax-saving goals.

To Wrap It Up

In conclusion, fixed deposits are a popular investment option for those seeking low-risk returns. While they offer stable returns, it is important to consider factors such as inflation, tax rates, and interest rates before investing.

Looking for higher returns than an FD? Investing in stock markets tends to produce higher returns as compared to a fixed deposit, however, it also comes at a higher risk. You can consider investing in stock markets through diversified, readymade stock or ETF portfolios curated by SEBI-registered experts on smallcase. Try now!