Fixed deposits (FDs) as an asset class have traditionally been favourites with a large section of the investing community. Infact for some investors, investing in a fixed deposit is synonymous with investing itself. However fixed deposits come with a fair amount of baggage. We at Personalfn have assiduously raised these issues over a period of time. Having said that there is a class of investors for whom FDs hold value despite their shortcomings.
For a risk-averse investor who refuses to take on any risk, FDs fit the bill to perfection. Small savings schemes also offer assured and attractive returns. However most of these schemes are suited for long term investments. Again the process of rationalisation of small savings schemes has begun, and these schemes in their new form may not be very attractive. Hence if you are looking at earning assured returns over a 1-3 year horizon, FDs emerge as a natural choice.
Now let’s go back to the “baggage” we spoke about. Inflation tends to be a problem area for most fixed return instruments and FDs are no different. Assured returns can be seriously hit especially in times of rising inflation like the present one.
Secondly liquidity can be an issue as well. It’s always a good strategy to maintain liquidity in your investments irrespective of the asset class your are invested in. Fixed deposits have conventionally ranked poorly on this parameter. Finally we have tax benefits; exemption from income tax is available under Section 80L only to the extent of Rs 12,000 pa. Beyond this level interest income is fully taxable.
How much do FDs offer you?
But there is hope for the fixed deposit investor. The need to make FDs more attractive has not been lost on institutions accepting deposits. Organisations like HDFC Ltd. have added features to their deposit schemes which eliminate some of the problems associated with conventional FDs. Liquidity problems have been tackled by making provisions for premature withdrawals across the counter after completion of a 3 month tenure. Similarly loans (upto 75% of the deposit amount) can be availed across the counter. Now the caveat, these facilities come at a cost i.e. loss of interest and a high interest rate respectively.
What should your strategy be?
Foremost, get invested in a fixed deposit which carries the highest degree of safety i.e. a AAA rating. Stay away from company deposits which are not rated AAA, but offer attractive interest rates since they are inherently risky.
At Personalfn, we have advocated short-term deposits for current times. Short-term deposits will enable investors to counter any possible opportunity loss on account of a likely hike in interest rates.
Scrutinise the terms and conditions governing the FDs. Find out if premature encashment is possible, the ease with which it can be availed and the costs involved.
If a fixed deposit is the instrument which suits your profile, go ahead and get invested; but ensure that the downsides are reduced to the extent possible.
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