The interest rate on the fixed deposit is pre-determined at the time of making the investment and remains constant over the period of investment. There a couple of factors that affect the fixed deposit interest rates mentioned below:
The interest on fixed deposit is calculated by two methods, simple interest, and compound interest.
We have explained the calculation formula through both the methods below.
Comparison of Mutual Funds Returns with Fixed Deposit Returns
Mutual funds and fixed deposits are both good investment options for an investor. Below is a table reflecting the differences between the two options:
||A type of deposit made with a bank wherein investors put a specified sum of money for a fixed tenure.
||The investment made by different investors is pooled together and invested in shares, stocks, instruments, bonds.
||The rate of interest is pre-determined and guaranteed over a specific period of time
||The returns are dependent on the market fluctuations and performance of the mutual fund in the market in case of equity funds.
||Risk is close to zero as the investor will get a guaranteed return. This deposit guarantee is also backed by DICGC, a subsidiary of RBI up to Rs 5 lakhs
||The risk involved varies from fund to fund and is influenced by the market (in case of equity funds).
||No expense from the creation of FD till maturity
||Mutual fund carries fund management charges and expenses
||It cannot be liquidated before the maturity period. Penalty applicable for premature withdrawal
||It can be withdrawn free of charge after the lock-in period. Premature withdrawal is allowed with charges of 1% in the form of exit load.
||Principal amount- Allowed as a deduction (if tenure is greater than 5 years) Interest Amount- Taxable Interest greater than Rs 10000- TDS deductible @ 10%
||STCG- Flat rate of 15% LTCG less than Rs 1 lakh- Tax-free LTCG more than Rs 1 lakh- Taxable @ 10% LTCG on Debt funds- Taxable at 20% post indexation
Features and Benefits of Fixed Deposit
Higher interest rate
The interest rate on a fixed deposit is higher than the interest rate offered on savings account deposits. The interest rate is higher for a longer tenure of investment.
The returns on a fixed deposit are predefined and are considered guaranteed, this interest does not depend on any market fluctuations. At the time of making the deposit, an investor is well aware of the maturity amount to be expected.
This is the reason why an investor may consider investing a part of his investment in a fixed deposit.
The principal amount invested in a 5-year tax saver fixed deposit is allowed as a deduction under section 80C up to Rs 1,50,000 under the Income Tax Act, 1961. The interest is added to the income of the taxpayer and taxed at the applicable tax slab rates
Flexibility of tenure
The tenure on a fixed deposit is flexible. An investor can select any tenure ranging from 7 days to 10 years. An investor can invest in multiple fixed deposits with different tenures with the same bank or different bank.
Hence, an investor can invest in fixed deposit for the tenure that suits his/ her liquidity and investment goal
An investment is liquid when it can be easily converted into cash. In case of emergencies or otherwise, an investor is free to withdraw the investment. A small penalty fee will be levied and the balance amount will be credited to his bank account.
Alternatively, an investor can avail of a loan against the fixed deposit.
Avail a loan
An investor can avail of a loan against a fixed deposit in case of emergencies. A loan can be availed up to 90% of the principal amount invested.
An investor will earn interest on the fixed deposit and pay interest on the loan. Hence, effectively an investor will get a hit of the balance of these two interests.
Disadvantages of Fixed Deposit
Tenure of deposit
The investment is made for a fixed tenure at a predefined rate. So the fixed deposit interest rate will not change with changes in market and inflation. An investor might end up with a lower return due to inflation.
The fixed locked-in tenure puts an investor in a situation where the withdrawal is not allowed, a premature withdrawal comes with a cost i.e. a penalty. Due to this penalty the net amount to be received on maturity decreases.
An investor can then choose to invest for a shorter duration, but a duration less than 5 years will not attract tax benefit u/s 80C.
The interest rate is a factor of tenure and is predefined which means the inflation rate is not considered and the rate of interest is not adjusted to provide an effect of inflation on the investment.
Tax on interest earned
The principal amount is allowed as a deduction ( up to Rs 1.5 lakhs under Sec. 80C) but the interest earned is taxable. The interest earned is taxable as per the income tax slab rate applicable to an investor.
If the interest earned is greater than Rs 10,000 TDS @ 10% will be deducted. This lowers the interest amount credit in-hand for an investor.
Penalty for premature withdrawal
Before investing, an investor must be sure about the tenure of investment and liquidity position during the investment tenure. A premature withdrawal attracts a penalty and lowers interest.
Hence, an investor can invest for a shorter duration and keep reinvesting. But doing this will not give an investor tax benefit u/s 80C.
Insurance of the amount deposited
The amount invested in fixed deposits is insured by the DICGC up to Rs 1 lakh per bank per account. So, if an investor has invested say Rs 3 lakh and the bank fails the DICGC will secure only Rs 1 lakh. This is a major drawback.
An investor must diversify his/ her investment among various banks to be insured
Comparison of Tax Saving Fixed Deposit with ELSS Funds
ELSS and fixed deposits are both good investment options for an investor.. Below is a table reflecting the differences between the two options:
||A type of deposit made with a bank wherein investor puts a specified sum of money for a fixed tenure.
||A category of mutual funds in which funds are invested in the equity market.
||Fixed return as per the rates offered by the bank
||Dependent on the market conditions and returns vary as per the performance of the market.
||It cannot be liquidated before the maturity period (5 years at least). Penalty applicable for premature withdrawal
||It cannot be liquidated before the specified period of 3 years.
||Principal amount- Allowed as a deduction (tenure is greater than 5 years)Interest Amount- Taxable
||Capital Gain less than Rs 1 lakh- Tax-free Capital Gain more than Rs 1 lakh- Taxable @ 10%
||Normal FD- Tenure of investment Tax Saving FD-5 years
Both the investment options have their own benefits and drawbacks but it depends on an investor, his financial goal and the risk he is ready to put. No doubt, investing in equities brings a market fluctuation risk with itself but also carries returns higher than fixed deposits.
The definition of risk is different for every individual investor, for a middle-aged man with high income and controlled expense and cost of living the risk tolerance level will be different from a just graduated medium income earning investor who does not have any commitments.
Fixed deposits are secure and chances of a fixed deposit failing are marginal but the call to invest in which option depends on an investor.
Insurance on Fixed Deposit
An investor might consider the risk of a bank closing down and the risk of losing the entire invested amount.
Every bank secures all the deposits made by account holders and investors including savings, fixed and recurring deposits. The bank deposits are secured by Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve Bank of India.
The deposit insurance scheme covers private banks, public sector banks, and co-operative banks.
The deposit guarantee can be released only in the event of the failure of a bank. This deposit guarantee covers Rs 5 lakh including principal amount and interest earned.
All the deposits and interest in any branch are clubbed together and up to Rs, 5 lakhs repaid to the investor in the event of failure.
Loan on Fixed Deposit
During an emergency of liquidity, people tend to take a loan through many sources. The amount of loan is dependent on the FD deposit amount. A loan can be availed up to 90% – 95% of the deposit amount.
A fixed deposit as a collateral
One such source is keeping a fixed deposit as collateral and taking a loan against it rather than paying a penalty and breaking an FD
Since the loan is taken against a collateral i.e FD, it is a secured loan and hence the rate of interest is lower than a personal loan and other types of loans
Eligibility for availing loan
- The loan can be availed by an individual investor or those with joints accounts
- The Loan cannot be availed against a tax-saving fixed deposit
- A fixed deposit in the name of a minor does not qualify for a loan.
The benefit of availing a loan against an FD is listed below
- No processing fee
- Quick loan disbursal
- Lower rate of interest compared to personal loan interest rate
- Loan available against domestic FD and NRI FD
- It can be repaid in lump sum or installment but before the expiry of FD tenure.
How does FD work in India?
A bank operates in two verticals i.e. borrowing and lending. A bank borrows from its customers i.e deposits and lends to its customers i.e loans.
A bank provides a safe house to its customers to park their earned money and deposit with the bank. The deposit can be in the form of savings account, fixed deposits or recurring deposits. The banks provide loans such as home loan, education loan, personal loan, business loan and others
On one hand, the bank borrows funds from its customers and on the other hand, it lends to its customers. Both come with an interest receivable and payable, this is how the banks work.
If you know how banks work, let us understand how fixed deposits work in India. Banks need a way to raise funds to lend their customers and so fixed deposits are available with all of the banks in India.
In a fixed deposit, the amount deposited is blocked for the period the deposit is made. The FD rate of interest depends on the period of investment. The interest amount depends on the rate of interest, amount invested and the period of deposit.
The depositor has the flexibility to choose a deposit period from 7 days to 10 years, but no flexibility when it comes to withdrawal. A premature withdrawal comes with a withdrawal penalty making it difficult and demotivating to withdraw, instead, a depositor can take a loan from the bank by putting the FD at stake.
Given the above parameters, an investor must choose the period very carefully and try to split the deposits in different banks as the DICGC will insure the FD amount up to 1 lakh only per bank.
But before investing it is always advisable for an investor to first calculate the maturity amount which depends on the interest rate. The fixed deposit interest rate differs for every bank. Hence, use an FD online calculator and know the expected amount.
What's the difference between Fixed Deposits and other investments?
When it comes to saving and parking money, a fixed deposit is the most option thought of in an investor’s mind. The reason is fixed deposit is considered as the safest and oldest saving instrument.
But with a change in time and market opportunities, the preference is getting switched from fixed deposit to debt mutual funds.
A debt mutual fund majorly invests in debt instruments like government instruments and bonds, corporate bonds, bills of exchange, etc. It also invests a portion of the fund in equity mutual funds which invest in debt instruments
Both the investment options have few differences as mentioned below:
Fixed deposits are not liquid and not flexible when it comes to withdrawal. The amount is locked and premature withdrawal comes with a penalty. But debt mutual funds are liquid enough, an investor can withdraw the investment without any lock-in period constraints without depreciating the fund value.
The interest rate on a fixed deposit account is pre-determined at the prevailing rate at the time of making the deposit. It does not consider inflation and loss of currency value. The rate of return on a mutual fund is inflation-adjusted and has the ability to generate better returns.
The rate of interest on a fixed deposit is fixed and does not get affected by any factor during the entire deposit period. The rate of return on a debt mutual fund changes with changes in the market conditions i.e. when the market goes high, the rate of return increases and vice-versa.
The interest on FD is added to the total income of the taxpayer and taxed as a tax slab rate. The return on a mutual fund is taxed on the basis of the period of holding. The period of holding drives a long-term capital gain and a short-term capital gain and the applicable tax rate.
What are the advantages vs. disadvantages of FD vs. other investments?
The advantages vs. disadvantages of FD vs. other investments i.e. debt mutual funds are listed below:
Advantages of FD vs. other investments
- The fixed deposit if deposited for a period of 5 years is termed as tax-saving fixed deposit and allowed as a deduction under section 80C of the Income Tax Act, 1961 up to Rs 1.5 lakh. Unfortunately, the debt mutual funds do not carry such benefits
- Since the debt mutual fund is moved by the market fluctuations, a downward trend in the market will affect the returns and inflation adjustment in the returns. But with a fixed deposit, there is no such matter to worry about, the rate of interest if fixed with no changes expected
- An investor can claim a loan by putting his/ her fixed deposit as collateral. The debt mutual fund carries no such option.
- An investment in debt mutual fund comes with an expense ratio, this is the annual maintenance charge charged by the fund manager in exchange for the portfolio management. A fixed is free from any of such expenses.
Disadvantages of FD vs. other investments
- The debt mutual funds have the benefit of liquidity, i.e. no lock-in period and withdraw the investment any time. But the amount invested in a fixed deposit is locked for the period of deposit. The hands of an investor will be tied up until he/ she withdraws bearing a penalty or wait for the lock-in period be over
- The interest rate on a fixed deposit is fixed on the day of deposit, leaving any effect of inflation or market fluctuations behind. The debt mutual fund on the other hand, since moved by market fluctuations is inflation-adjusted and with high market movement, the interest also increases.
- A fixed deposit is a better option than a savings bank account or similar investment option under the same investment category but carries a lower return earning opportunity than a debt mutual fund
Now we know in detail the advantages and disadvantages of FD vs. other investment, the decision to invest in a fixed deposit or a debt mutual fund depends on the investor. It depends on his/ her risk-bearing capacity.
The risk, on the other hand, varies from person to person, for a young medium earner with the average cost of living the risk appetite will different from a man who is aged 51 years waiting for his retirement in the next 9 years seeking a known and low-risk investment option.