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7 Reasons why Fixed Deposits (FD’s) are not so good for You?

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fixed depositFixed deposit or FD is one of the most popular financial products today. There are several reasons for its popularity more than just the returns offered. It is a very simple product to understand and invest. There is also a guarantee of the returns offered. What else would you want? Don’t you think this is the best place where you can put your money? If you do, just think again. Let’s list out 6 reasons why FD’s are not quite good for you.

Reason 1 – No Tax Benefits

Fixed deposits in general do not provide any tax benefits for you. Only the deposits of tenure above 5 years qualify for tax deduction under section 80C. Rarely does one opt for such longer tenure deposits. Moreover, these are unlike regular deposits and cannot be withdrawn. Sweep-in or overdrafts are also not allowed on such deposits. So the tax deduction that you intend to claim through these tax saving deposits come with some conditions. When there are so many instruments that can be used for deduction under section 80C, FD’s are not such a good choice for this purpose.

Reason 2 – Low Returns post tax

FD gives a return of around 9-10% p.a. For senior citizens, it is 0.5% more than the usual rate. However, have you ever considered its post tax returns? If you are in the 10% tax bracket, it may not make much of a difference to you. But, if you are in the higher tax brackets, your post tax return will come down drastically. The 9% return promised will become 7.2% and 6.3% for 20% and 30% tax brackets respectively. When you compare these returns with an inflation of over 10%, you know how good your investment has fared.

Reason 3 – Interest rate risk

When you are investing in a fixed deposit of 1 or 2 year tenure, you are locking your investment for 1 or 2 years. Once you withdraw your amount or renew the deposit, you should be looking at the interest rate prevailing at that point in time. There are many chances that you might get a lower interest rate than the one offered to you earlier. The rates are subject to volatility especially in this volatile interest rate scenario where RBI keeps changing interest rates on a constant basis.

Reason 4 – No Liquidity

The lock-in on your deposit also means that you would not be able to withdraw amount from your deposit till maturity. Compare it with a liquid fund which allows you to withdraw money in a span of 24-48 hours and the rest of the amount keeps receiving the interest.

Reason 5 – TDS on the interest

If you have taxable income, TDS will be deducted on the interest received from your fixed deposit. In general, it is not really bad as you have to pay tax on your income anyways. However, there are instances where TDS has been deducted despite you submission of form 15 G/H. There are also cases where banks misplace the PAN numbers and you would have to show various proofs in order to get it corrected. You would also have to apply for a refund of the TDS amount at the time of tax filing. People who have filed their taxes 6 months back are still waiting for their refund amount.

Reason 6 – Flexibility

I believe this is the major difference between an FD and a Mutual Fund. You do not have the flexibility of investing in phases in an FD, whereas in a Mutual Fund, you can invest via SIP/STP. You can choose your SIP amount and invest in it systematically and this amount can be as low as Rs. 500 or Rs.1000. This also introduces to you a concept called ‘Rupee Cost Averaging’.

Reason 7 – Withdrawal penalty

Fixed deposits can be withdrawn within the maturity date, but with some penalty. Penalty varies from bank to bank. It can be in the range of 1-2%. There is a specific formula for calculating the withdrawal penalty on breaking a fixed deposit. Such penalty might seem to be low but if the invested amount is in lakhs, this penalty would be a few thousands.

Final Word

These are some of the reasons why you should consider alternatives to fixed deposits for investing a lump sum amount. That does not mean FD is not a good investment. If your requirement suits it, you should go for it. It is better if you do a quick review of the above points before you pick it up.

  • Ramamurthy

    FD Vs Debt schemes of Mutual Funds? Can you please do a write up?

    • Av Suresh

      Ramamurthy, we have an article on this topic already. You can read it here – http://www.investmentyogi.com/planning/debt-mutual-funds-vs-fixed-deposits.aspx

      • Ramamurthy

        Thank you. I read the article and have posted a comment. Eagrly awiting a response from you. ramamurthy

        • Av Suresh

          You can view our response above. The link contains an article on the topic specified by you.

          • Ramamurthy

            Which link are you talking about please. I was referring to investments in a specific Debt Fund viz Sundaram Gilt Fund. This fund invests in 91 days Treasury Bills which gives about 8.5% return.One Year return from this fund to the investor of this Fund is 18%. How is this possible?

          • Av Suresh

            Yes, Sundaram Gilt fund has provided such returns. You can check for its returns in various online portals. The reason for such returns is variation in interest rates. However, the 5 year returns for this fund is only 7.54% CAGR.

  • Devdatta

    Did you miss the capital protection? Also in reason 4, lock in is only for tax saving FD not all where we get money within an hour to 24 hrs.

    • Av Suresh

      Devdatta, yes capital protection is there in products such as FD, RD, PPF, NSC or Debt mutual funds. Some banks charges for breaking an FD whereas others don’t.

  • Sa

    Things will change if you talk about NRE deposits. Interest rates are same, No Tax but min term is 1 yr

    • Av Suresh

      Yes, you are right. Interest from NRE deposits is tax exempt. However, even they are not totally safe. There are risks such as conversion loss, exchange rate fluctuation, etc in these deposits. What I meant to explain in not to ignore FD’s totally but to look at other options as well. Why only one product when there are many available. Don’t you think diversification is the best strategy?

      • Sa

        RBI came with a scheme few month back for NRIs to control Rupee Depreciation. Under that scheme, NRI were able to get 15% to 18% assured return. It was all mix of Fixed Deposit and currency contracts. NRI cant get that much return in any secured investment.

        Exchange plays a important factor, but end of the day, you need to see how much risk you are ready to carry. This risk will always stays, if you keep in FD in India or aboard or any other investment. Its not easy to convert INR to other currency, vice-versa is in seconds.

        Diversification is ofcourse best strategy. One shouldn’t limit to FD. According to risk factor, one should have money in Gold, equity/ Mutual fund, property etc. Nothing in world is best, one needs to find opportunities pertaining to that time.

  • Ronald A R

    Its a fashion adopted by all MBAs and so called Financial wizards to discourage FDs and encourage Mutual funds. If you ask for feedback from those who have ventured into MFs based on such advices, I am sure that 90% of them have burnt their fingers and on an average not earned more than 2 to 3% after deducting various bank charges. This is apart from other headaches one has to go through in managing the portfolios. Even with 7% average returns after tax from FDs you are safer. Inflation is not always 10%. Average inflation is much less.

    • Av Suresh

      Ronald, as I said in this article, FD is not a bad product. However, if someone does not have the expertise/time/knowledge to venture into mutual funds, it is better to invest in simpler products like FD’s, PPF, RD, etc.

  • Deepak

    Mutual funds are not transparent at all. From my personal experience, getting profit out of mutual fund is 100 times more difficult than getting from FD. There is no strict regulation on how much fund management charges should be, how many portfolios a mutual funds can have, what are the max number of fund switch allowed and at what cost. All these factors are decided by mutual fund managers, into which customer has no say. Moreover, fund manager (or the company) do not bear any risk. If the fund value goes down, they get their commission (management charges) and if it goes up, they get it as well. All risk is on the customer.
    If you have enough knowledge & time to get profit from mutual funds then you can definitely get more profit out from direct market (share, derivate etc.) investment.
    FDs are on contrary, are good for simple person with limited financial knowledge or a person who have better things to do than invest time in evaluating financial products.
    Bear in mind that you need to pay taxes on mutual fund payments as well and it is deducted as TDS which you need to claim later back. It can give you some tax relief initially but a big risk, even for 30% tax slab saving.
    I’ll say either take control in your hand and do direct market investments or just choose simple products like FDs, RDs, post office savings etc.

    • Av Suresh

      Deepak, the discussion in the article is not about FD’s versus Mutual funds. I have listed out some of the reasons why FD’s are not so good for you. If you do not like to venture into mutual funds, there are other products such as PPF, NSC, MIS, etc. PPF is a wonderful product for long term with great tax benefits. Debt mutual funds enjoy indexation benefits after 1 year. Equity funds are completely tax exempt after 1 year.

  • csrao

    Suresh, would you please provide from NRE point of view FD details, whether upon NRI status is lapsed interest is taxable or not.

    • Av Suresh

      Tax exemption for NRE fixed deposits is provided only for NRI’s. Though you get the same interest rate upon returning to India, tax exemption will not be applicable anymore.

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