Would you rather keep your money idle or invest it to earn some returns? The answer is obvious. Since childhood, Indian parents teach their children the importance of money, savings, and investments. The most popular form of investment in India is Fixed Deposit. As per a survey report published by SEBI in August 2019, 95% of Indian households preferred to make a fixed deposit investment in rural as well as urban areas combined.
While there are numerous investment options on the market, including recurring deposits, PPF, stock markets, mutual funds, bonds, commodities, currencies, etc, what makes fixed deposits such a preferred investment option? This blog answers all your questions regarding fixed deposit and what you can expect from an FD investment.
What is a Fixed Deposit?
Fixed Deposits are investments that pay a fixed interest income over an agreed-upon tenure. Fixed Deposits can be issued by Banks as well as NBFCs. Based on your preference, you can choose to either withdraw this interest or reinvest it and enjoy compounding benefits.
Fixed Deposit: Definition, Advantages, & Working Principle Explained
You can invest in an FD for the short, medium, or long term. Depending on your fund requirements and the purpose of investment, you can select a fixed deposit time period between 7 days to 10 years. Here are the advantages and working principles of a Fixed Deposit.
1.1 Advantages and Benefits of Fixed Deposit
Having learned about a fixed deposit, let’s look at the pros and cons of fixed deposit investments.
- Developing a Habit of Saving: The best way to build capital for yourself is to save regularly. It should be a priority for you to save a portion of your earnings and invest it. You can invest in FDs on a lump sum basis or allow your bank to auto-sweep a part of your earnings that are planned for investments as per your preference
- Safer Investment: As an investor, one of your major concerns is the safety of your money. FDs with an aggregate value of ₹5 lakh held by an investor with a bank are covered under the DICGC insurance cover. This makes your invested money safe
- High Returns: Banks and NBFCs pay a higher rate of interest on fixed deposits in India compared to government securities like Treasury Bills or Gold Bonds
- Save Taxes: With some types of FDs that are tax saving or senior citizen FDs, you can get a deduction on your investments up to ₹1.50 lakh every year from your taxable income
- Premature Withdrawal: Suppose you make an FD for three years. After three months, you need urgent money. You can easily make a premature withdrawal of the fixed deposit as there are no restrictions. Although banks and NBFCs deduct 0.50-1.00% interest on premature withdrawals, your corpus remains intact
- Higher Interest for Senior Citizen: If you are a senior citizen, you can gain additional perks for investing in an FD. Usually, banks and financial institutions pay higher interest rates on senior citizen FDs compared to the normal ones
- Overdraft against FD: If you hold an FD and do not want to make a premature withdrawal, you can ask your bank to provide an overdraft facility against it. Banks in India finance up to 90% of the FD value as an overdraft. In the case of FDs created online, you can also get an instant overdraft from the bank’s website against this FD
1.2 How Does Fixed Deposit Work?
Before investing in a fixed deposit, it is important to understand the mechanism through which FDs work. Here are all the details of how a fixed deposit works.
1.2.1 Choose the Type of Fixed Deposit
You can open a fixed-deposit account with a bank or an NBFC. While you can invest in an FD both online and offline, getting an overdraft on your FD is much easier with online FDs. There are different types of FDs available. But, you should check these points to select the best one for you:
- Aim of Investment: Your investment preference depends on your investment objectives. If your goal is for the short term, the requirement of capital and tenure of investment will change accordingly. Similarly, to achieve a long-term goal, you need a different investment strategy.
- Type of Income: If you are a salaried individual, you can save regularly. Hence, the best option for you is either an FD with an auto-sweep facility or a recurring deposit. On the other hand, if you are a businessperson, you can save in bulk. Hence, investing a lump sum amount in fixed deposits can help you grow your capital.
- Risk Appetite: If your risk appetite is very low, and you do not want market volatility to affect your investments, you should opt for investing in a fixed deposit.
1.2.2 How is the Interest Calculated?
- If you break your FD within 7 days of investing, no interest is paid on it
- Banks and Financial Institutions in India pay interest on fixed deposits every 3 months
- According to your preference, you can choose to either withdraw this amount or reinvest
- If you need a regular flow of funds, then you should opt for non-cumulative fixed deposits. They provide regular income to the investors
- If you want to grow your funds and do not want a fixed stream of income, you should invest in a Cumulative Fixed Deposit, which automatically reinvests the earned interest on FD
1.2.3 What is the Tenure of a Fixed Deposit?
- The tenure of fixed deposits in India is anywhere between 7 days to 10 years
- You can choose the tenure according to your fund requirements and the goal of the investment
- The tenure of Tax Saving and Senior Citizen FDs is 5 years. Hence, your investment remains locked in during this period, and you cannot make a premature withdrawal
1.2.4 Auto-sweep-in Facility
What is a fixed-deposit auto-sweep-in? While people think that FDs are only meant for lump sum investments, you can access an auto-sweep-in option for investing regularly. Let’s see how it works:
- You need to have a savings bank account in your name with the same bank with which you want to open a fixed deposit
- You need to give a consent form to the bank for enabling the auto-sweep-in option on your savings account, along with the auto-sweep-in amount and the benchmark balance, after which auto-sweep-in is triggered
- Whenever your savings account balance crosses the above benchmark, a fixed deposit is created with the auto-sweep-in amount
- For Ex: You want to keep a balance of ₹50,000 in your Savings Account, and you set the auto-sweep-in amount at ₹30,000. So, the auto-sweep-in will be triggered as soon as your account balance reaches ₹80,000. The following table shows clearly how an auto-sweep-in facility will work on your savings account.
|Date||Opening Savings Balance (₹)||Amount Received (₹)||Total Balance (₹)||New Auto-Sweep-in FD (₹)||New Savings Balance (₹)|
|1st March 2022||30,000||50,000||80,000||30,000||50,000|
|1st April 2022||50,000||50,000||1,00,000||30,000||70,000|
1.2.5 Compound Interest
This is by far one of the major benefits of investing in a fixed deposit. Suppose, you invest an amount of ₹5,00,000 in an FD from March 2022 for a period of 3 years at 6% p.a. compounded every quarter. Here is the table showing how fixed deposit interest is calculated:
|Month||Opening Balance (₹)||Interest @ 6% p.a. Paid Quarterly (₹)||Closing Balance (₹)|
|Total Interest & Effective ROI||97,811||6.52% p.a.|
The effective return on investment for 3 years on a 6% p.a. FD compounded quarterly is 6.52% p.a. This is due to the additional returns provided by the compounding effect of paying further interest on the accrued interest.
1.2.6 Premature Withdrawal
You can close your FD before the due date if you need funds urgently. Banks and FI deduct almost 0.5-1% of the interest amount as a penalty. But, it allows you to maintain your liquidity.
1.2.7 Overdraft against FD
While most FDs do not have a lock-in period, Tax Saving and Senior-Citizen FDs are locked in for 5 years. And eventually, you are charged a penalty on the entire interest for premature withdrawal. To avoid this, you can apply for an overdraft against your FD, which allows you to use the funds and pay interest only on the amount actually withdrawn.
1.2.8 Fixed-Deposit Rules & Regulations
While all the banking instruments in India are regulated by the RBI, it is important to understand the implications of Income Tax on your interest income:
- Income From Other Sources: FD interest earned is grouped under the head Income from other sources. Tax is charged at normal slab rates according to the assessee. Every bank and FI deducts and deposits TDS from the interest paid to customers
- Deductions U/s 80C: You can claim a deduction of up to ₹1.50 lakh in every assessment year by investing in Tax Saving and Senior-Citizen FDs. The tenure of these FDs is 5 years, and you cannot withdraw any amount before maturity
- Form 15G/H: Individuals having income less than the basic exemption limit can file Form 15G/H with the banks and FIs. Accordingly, you get an exemption from TDS deductions on your FD interest
Types of Fixed Deposits
- Cumulative Fixed Deposits: The FDs that automatically reinvest the interest accrued on your FD are called Cumulative FDs. Hence, they provide the benefit of compounded returns
- Non-Cumulative Fixed Deposits: FDs that pay interest to the customers at regular intervals are called Non-cumulative FDs. Unlike cumulative FDs, you can earn only simple interest on a non-cumulative FD
- Tax Saving FDs: By investing in Tax Saving FDs, you can claim a deduction of up to ₹1.50 lakh in every assessment year under Section 80C. The duration of a Tax Saving FD is 5 years
- Senior Citizens Savings Scheme (SCSS): These are special FDs for investors above the age of 60 years. While the tenure is 5 years, SCSS provides 0.5-1% extra interest to the investors
- Flexi Deposits: Unlike recurring deposits where you have to invest a fixed amount every month, Flexi deposits allow you to invest a different amount at your convenience
- Corporate FDs: Corporate FDs are investments made by corporates with banks and financial institutions. By producing them as collateral security, corporates can get different funded as well as non-funded credit facilities
- Postal Fixed Deposits: With the integration of post offices into the banking system, investors can create FDs with the post offices called the Post Office Savings Scheme. However, the drawback is that they can only be created offline
Top Reasons Why You Need a Fixed Deposit?
- Balances Out Your Investment Portfolio: FD investments are not affected by market risks, and bank FDs are even insured by the DICGC. Hence, you can invest in a fixed deposit to balance the risk of your overall investment portfolio
- Capital Stays Intact: FDs do not erode your invested capital. Even in the case of premature withdrawal, only a portion of the interest amount is deducted. Hence, your capital remains intact
- Always Provides Positive Returns: Due to no market fluctuations and no additional charges on your FD investments, the interest is fixed over the tenure of the FD. Hence, an FD investment always grows in a positive direction
- Suitable for Short-term Goals: There is almost no risk in an FD for the short duration. You can easily calculate your fund requirement and invest accordingly
- Flexible Tenure: You can invest in a fixed deposit for 7 days to 10 years. The interest rates are lower in the short term as compared to long-term FDs
- Invest & Break Online: You can easily create and break your FDs through the online websites of the Banks and FIs
4. Fixed Deposit vs Recurring Deposit vs Mutual Fund vs P2P Investments: Understanding the Differences
4.1 What is a Fixed-Deposit Account?
As we have already discussed, a Fixed Deposit or an FD is an investment option provided by banks and NBFCs. It helps the investors grow their money over a fixed period at a certain rate of interest without being subject to any market risks.
4.2 What is a Recurring Deposit?
It is an investment instrument offered by banks and allows the investors to make regular deposits and earn interest on the investment. It is the most suitable for salaried people as they can invest a certain sum every month and earn interest. The rate of interest is fixed and does not change throughout the RD term, offering a safe investment option to the investors.
4.3 What is a Mutual Fund?
A mutual fund is a financial instrument that pools money from multiple investors to invest in stocks, bonds, and other financial instruments. These funds are managed by professional fund managers that allocate the funds to maximise the returns. Mutual funds are influenced by market fluctuations and involve risk. They can also earn handsome returns to the investors.
4.4 What is a P2P Investment?
P2P or peer-to-peer investment is a loan given by an individual to another individual. These are direct lending-based investment opportunities that can be accessed through online P2P platforms like LenDenClub. Along with higher returns compared to fixed deposit, a P2P investment provides many benefits to the investors, e.g. P2P investment is not subject to market volatility as mutual fund investment is.
4.5 Recurring Deposit VS Fixed Deposit
While both FD and RD investments provide a fixed interest on your invested capital, there are some points of difference between them.
|Particulars||Fixed Deposit||Recurring Deposit|
|Time of deposit||The investor has to invest a lump sum amount and make a one-time payment||The investor can divide their investments throughout the RD term, and invest a particular sum at regular intervals and earn interests|
|Who can open||A Fixed Deposit can be opened by anyone who has an active bank account. FD can be opened with a bank, an NBFC, or any other financial institution||A recurring deposit can be opened by anyone who has a regular source of income. For example, salaried employees|
|Tenure||An FD tenure can range from anywhere between 7 days to 10 years||The minimum tenure of an RD is 6 months and can go up to 10 years|
|Returns||The interest earned on an FD is higher than the interest earned on an RD. This is so because all the amount is deposited at once, and the interest is earned accordingly||The interest earned on an RD is lower than the interest earned on an FD|
4.6 Fixed Deposit vs Mutual Fund
While fixed deposits are debt-based investment instruments, mutual funds invest in either debt or equity or both. Here are the key differences between these two investment options:
|Particulars||Mutual Fund||Fixed Deposit|
|Risk||Mutual fund is risky as it is affected by market fluctuations, and any change in the stock market dynamics affects the returns on mutual-fund investments||Fixed deposit is a safer option as it is not subject to market volatility|
|Potential Returns||The return on a mutual fund depends on the performance of the stocks in which the amount is invested. The return from a mutual fund is not assured||Fixed deposit provides a fixed return over a fixed period of time. The return is assured in an FD|
|Investor protection||Mutual funds are regulated by the SEBI||FDs are regulated by the RBI|
|Expenses||Mutual funds carry some charges like fund-operating expenses||FDs do not carry any charges or expenses|
|Withdrawal||Investors can make free-of-cost withdrawals from the mutual funds after the lock-in period. However, withdrawal within the lock-in period costs 1% of the deposit amount||Withdrawing within the tenure of the FD requires the investors to break the FD and pay a penalty|
5.How Can LenDenClub Provide an Alternative Investment Option?
While a fixed deposit is a safer investment option, it doesn’t provide adequate returns to the investors. With the prevailing FD interest, you can hardly beat the inflation. On the other hand, stock markets are highly volatile and can lead to capital erosion. Hence, an alternative investment that provides stable and high returns is a great option. By investing in the LenDenClub P2P lending platform, you can get the following benefits:
- An RBI-registered NBFC-P2P
- Transaction made through an Escrow Account managed by a trustee
- Higher Returns between 10-12%
- Flexible Investment Tenure
- Lower Default Rates of approx. 3-4%
- Start investing with just ₹500
- Diversify your risk with multiple investments of up to ₹500 each
- Available across platforms: Website and Mobile App supported by both Android & iOS
- Thorough Borrower Evaluation over 200+ data points
- Support for repayment and portfolio management from the LenDenClub team
- Account Information on the go with detailed reports