Depositors have had a rough ride over the past two years, with bank deposit rates drifting down. Ever since the RBI began to cut its policy rate in January 2015, banks have been cutting rates on deposits with alacrity. Demonetisation only made matters worse. Banks flush with funds slashed deposit rates to lower their costs. Between January 2015 and October 2016, deposit rates (weighted average) fell by 120-130 bps (or 1.2-1.3 percentage points) across banks. And from November 2016 to December 2017, rates on fixed deposits fell by an additonal 80-90 bps.

But the tide is slowly turning in favour of savers, with a few banks increasing deposit rates over the past month. If you have surplus funds or your existing deposits are soon maturing, it’s time to review your fixed-deposit investment strategy.

‘Timing the market’ can make a striking difference to your returns from bank deposits, just as your ‘time in the market’ can. Deposit rates over the past 45- and 20-year periods show some interesting trends that we can draw lessons from.

For the long haul

As a depositor, you cannot escape the ups and downs in interest rate movements. But you can still make a sizeable difference to your returns over the long run by locking in at the right time and choosing the right tenure.

Typically, it is your cash flow that decides the tenure of your deposit. For instance, if you can park your money only for three years, you have no choice but to go in for deposits with a similar tenure. But many of us can set aside money for the long run.

Our study reveals that for such depositors, rate cycles matter little in deciding the tenure of deposits.

Locking into longer-term deposits gets you better returns, whether at the end or the beginning of a rate-easing cycle.

We analysed deposit rate trends since 1970-71, considering three tenure buckets — one-three years (short term), three-five years (medium term) and over five years (long term).

We have assumed that deposits are reinvested at the rate prevailing at the time of each maturity.

Across both the 45- and 20-year periods, investors who went in for long-term deposits earned higher returns than those who stayed with short-term deposits, irrespective of whether money was locked in at the peak or the bottom of the rate cycle.

Over a 45-year period, the annual returns worked to about 8.8-9 per cent (at the bottom-of-the-rate cycle) to over 9.5 per cent (at the peak) if you opted for medium- and long-term deposits. However, for the short term, it was just 8.2-8.4 per cent.

If you invested ₹1 lakh, the difference in the final maturity amount could be over ₹10 lakh (thanks to the power of compounding).

Over a 20-year period, the annual returns were 9.2-9.4 per cent for medium- and long-term deposits, while short-term deposits managed only 8.5-8.7 per cent.

Bottomline.If you are willing to lock in your money for a very long period, go for long-term deposits of over 7-10 years even now, at the bottom of the rate cut cycle. Since your time horizon is long, this will help you mitigate the risk of reinvestment at lower rates

For shorter periods

But many of us may not be able to lock into 10-year deposits. If you have a shorter (3-5-year) horizon, you cannot ignore rate movements in the economy. At the end of the rate easing cycle such as now, depositors will be better off going with very short–term deposits of one-three years (in general).

Deposit rates over the last decade or so show that if you had invested in short-term deposits at the end of the rate easing cycle in 2004 or 2009, your annual returns would have been 7.6-7.8 per cent, against 6.8-7.2 per cent returns on medium- and long-term deposits.

This is because locking into long-tenure deposits at the bottom of rate cycle could deprive you of the chance to benefit from higher rates when the tide turns.

Currently, rates have bottomed out, and a few banks have already started to increase deposit rates. Axis Bank increased its deposit rates by 65 bps in certain buckets recently. DCB, IndusInd Bank and Lakshmi Vilas Bank too have tinkered with their deposit rates.

It is therefore best to go in for very short-term deposits of, say, six months to one year. This will help you ride rate increases in the future.

Bottomline.If you have a five-year horizon, go for shorter-tenure deposits now so that you don’t miss out on higher rates. Generally, as rates are close to bottoming out, one- to three-year deposits are ideal to lock into. But given that a few banks have already started to hike deposit rates, choosing a much shorter—upto one-year—tenure will work out better for depositors with a medium-term horizon

What’s on offer

Most banks offer 6.5–6.75 per cent for deposits upto one year; a few offer slightly higher rates. RBL Bank offers 7 per cent on deposits from 91 days to 180 days, Kotak Bank offers 6.85 per cent for 390-day deposits, City Union Bank offers 7 per cent on 181-364 days deposits while Bandhan Bank offers 7 per cent for a one-year deposit. IDFC Bank offers 7.5 per cent for 366-day deposits.

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