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As investment options go, nobody seems to like the plain old FD or fixed deposit. With the stock markets doing so well, experts are recommending SIPs or other fancy vehicles and bashing up FDs for their inability to beat inflation. But FDs are like rotis in a thali. You may have any number of more glamorous and higher return products as side-dishes and desserts, but without FDs your portfolio is incomplete.
In this episode of Question of Money, I’m going to talk about how and where you need to use FDs and also how you can make a good return from them.
Even for investors who are willing to take the risk of stocks or equity funds, there are four use-cases for FDs.
#1 Beginners: If you’ve just started earning and are figuring out your investment options, you need not idle your money in a savings account until you choose your investments. You can park your money in a fixed deposit. A savings account lets you take out your money at anytime and typically pays you an interest of 4% per annum (some banks offer 6% if certain conditions are met). A fixed deposit locks in your money with the bank for terms ranging from 7 days to 10 years, and offers you a much higher interest rate than your savings account. Interest rates in the market have up and down cycles and FD rates tend to reflect that. Today FDs from banks offer anywhere between 6.5% and 8% pa.
#2 Emergencies: In our earlier videos, we’ve discussed the importance of having an emergency fund to meet contingencies like a pink slip, or an accident or a family illness. A bank FD is the best place to park this emergency money, because you can break the FD and receive money into your savings account almost instantly. With other vehicles like mutual funds, it can take 3-4 working days to get the money into your account.
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#3 Windfalls: If you’ve received a windfall from your employer, won a lottery or got rich trading derivatives, and would like to protect that capital at all costs, then a bank FD is your best bet to park this money. Ditto for retirees who have just got their retirement benefits and are figuring out where to deploy them. All bank accountholders enjoy deposit insurance protection upto Rs 5 lakh across their savings accounts and FDs in each bank. But if you want to be ultra-safe about protecting your capital beyond Rs 5 lakh, then you should invest in FDs of systemically-important banks as defined by RBI. Currently, SBI, ICICI Bank and HDFC Bank are deemed systemically important.
# 4 Debt allocations: No sensible investor has her entire portfolio devoted to one asset like equities or real estate. Financial planning calls for every investor to allocate her money across different assets such as equities, debt, gold, real estate and so on. FDs can play an important role in the debt portion of your asset allocation if you use them correctly. While bank FDs can seldom deliver inflation-beating returns after taxes, FDs from other entities can sometimes match inflation. Today for instance, FDs from AAA rated NBFCs like Sundaram Finance, Bajaj Finance, Mahindra Finance and some small finance banks offer 7.75% to 8.6% pa. Interest income is taxable in your hands at your income tax slab rate. So even if this interest gets taxed at say, 30%, you’ll be left with a post-tax return of 5.4%-6%.
FD strategy
Can there really be a strategy for a humble instrument like the FD? Yes, there should be, if you want to improve your returns. Here’s how you should get the most out of FDs.
When parking money in an FD the critical thing to make sure of, is that you are investing in an entity that is regulated and trust-worthy. Only FDs with regulated entities are safe. RBI allows all banks and a very select list of NBFCs to accept public deposits. Within banks, scheduled commercial banks are safer than co-operative banks. In NBFCs, AAA rated ones are safer.
For your emergency funds, don’t look at returns and choose banks FDs which can be liquidated anytime.
For large windfalls, again stick to systemically important banks for your FDs.
Like stock markets, debt markets also need timing to get good returns. Most people don’t realise this.
During Covid times, bank FD rates had fallen below 6%. Today some banks are wooing you with returns above 7.5% or even 8%. So when FD rates are at 6% or so, you need to invest in FDs with short tenors of say 6 months to one year. FDs can give you a really poor return, well below inflation if you lock into long-term FDs when rates are at the bottom of a cycle, like in 2020-21. But when rates are at a high like today, you can earn a pretty good return from FDs if you lock into 4-5 year FDs at 8% plus.
(Host: Aarati Krishnan, Producer: Anjana PV, Edits: Darshan Sanghvi, Camera: Bijoy Ghosh & Siddharth Mathew Cherian)
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