When it comes to choosing a safe investment option, many individuals vouch for Fixed Deposits (FDs). This is because FDs are considered safe, liquid, and provide assured interest income. Millions of Indians favour the surety of an FD.
But are FDs absolutely risk-free? The word “risk” is largely used in the context of returns and capital safety. If your capital is safe and your returns assured, the investment seems risk-free. Right? Wrong. Financial risks can be of many other kinds. Let’s take a look at various risks of investing in a fixed deposit.
A fixed deposit makes availability of funds easy. However, not all fixed deposits may be easily liquidated. For example, a tax-saver FD whose tenure is five years, can’t be liquidated before its term. If you have an FD at a bank that doesn’t permit online liquidation, you may have to visit a branch and fill out their paperwork, and it may be a few days before you get your money.
There are several returns-related risks in FDs. First of all, FDs may offer you a moderate rate of return between 6-8% in most cases. At the lower end of this returns spectrum, your interest earning may not be enough to compete with returns from small savings or Mutual Fund SIPs.
Bank defaults are very rare. However, theoretically, it’s a possibility. Your deposits – both principal and interest – at commercial and cooperative banks are guaranteed up to Rs. 1 lakh per bank. Therefore, if a bank were to default and unable to repay your deposit, the Deposit Insurance & Credit Guarantee Corporation were to cover you up to Rs. 1 lakh. If your losses are bigger than Rs. 1 lakh per bank, you may receive no compensation.
Your FD interest earnings may be completely taxable unless you’re over 60, where up to Rs. 50,000 is exempt under Section 80 TTB. Your interest earnings are combined with your income and taxed as per your slab. Therefore, if you’re in the 30% tax slab, a 7% FD may effectively be providing you only 4.9% — returns further diminished by rising inflation.
Low returns from FDs may not beat even the prevalent rate of inflation. For example, if your FD provides 6% returns while the inflation rate had crept up to 7%, your capital has actually eroded. In recent quarters, the inflation rate has been around 5%. Therefore, as a person in the 30% slab investing in a 7% FD, you’ve effectively earned 4.9%, thus earning less than the rate of inflation.
Some conservative, risk-averse investors prefer to save money only through FDs. This is also a risk. Having all your money concentrated into one form of asset means that you do not have diversification in your portfolio.
When you invest in corporate fixed deposits, you have to watch for credit risks. A corporate FD is assigned a credit rating by research agencies – FAAA, FAA, FA, etc. These signify a high chance of you getting your principal and promised interest back in time. However, companies with lower credit ratings – FB, FC, FD etc. – may have greater difficulties in repaying your debt.
What Should You Do?
As mentioned earlier in this article, fixed deposits have a definite role to play in your financial portfolio. They provide liquidity, safety of capital, and moderate returns. However, to invest via FDs alone is also a risk, for reasons mentioned above. Therefore, to earn higher returns, for diversification of assets, and to beat inflation, you must invest via mutual funds as well. Through mutual funds, you also have more tax-efficient instruments where your returns aren’t fully taxable in certain circumstances.
The writer is CEO, BankBazaar.