9 Reasons Why Risk Takers May Avoid Investing in Bank FDs

Since bank FDs offer security and guaranteed returns, they are preferred by risk-averse investors and senior citizens who typically cannot afford to invest in high-risk financial instruments. Fixed deposits also play a crucial role in balancing your portfolio, as when market-linked financial instruments like stocks and equity mutual funds get affected by market fluctuations and uncertainty in returns, bank FDs continue to deliver consistent returns.

While bank fixed deposits are an attractive investment choice in today's financial landscape, they come with certain disadvantages, especially for risk-takers. Hence, when making an informed financial decision, it is necessary to be aware of the flaws of this popular investment choice.

[Also Read: 5 Best Bank FDs for Senior Citizens And 7 Key Considerations to Make a Wise Choice]

Here Are 9 Reasons Why Risk Takers May Avoid Investing in Bank FDs:

1. Lower Interest Rates:

While fixed deposits offer a higher level of safety compared to other investment avenues, this safety feature is accompanied by a trade-off in the form of lower returns on your investment. The interest rate for a fixed deposit depends upon the Repo Rate, financial institution, the duration of the deposit, and, in some cases, your age. Generally, the returns from fixed deposits tend to be lower than those from other investment options, which is a significant drawback of this investment vehicle for those willing to take a medium to high level of risk.

2. Not Market Linked:

Another limitation of fixed deposits is that the interest rate is determined at the moment of opening the fixed deposit account. When you book a fixed deposit with a specific interest rate, you will receive interest at that rate throughout the entire FD tenure. It means you cannot benefit if the market is performing well.

3. Fixed Investment Tenure:

Fixed deposits come with fixed investment tenures, typically ranging from 7 days to 10 years. You can customise the tenure as per your requirement and must choose the one offered by the bank. For instance, suppose you want to invest a lump sum for your daughter's future higher education in a bank FD for 20 years. However, since most banks offer the maximum FD tenure of 10 years, you cannot invest that sum in FD for 20 years.

4. Lack Liquidity:

A fixed deposit lacks the same level of liquidity found in alternative investment choices. When you invest in an FD for a specific duration, you are required to maintain that investment until the end of the tenure. In cases of sudden cash requirements, you might find it challenging to access your funds since they are tied up in the fixed deposit.

Nonetheless, certain banks provide fixed deposits with the option of early withdrawal, allowing you to access your deposit before its maturity date. In such cases, the bank may charge premature withdrawal charges for early withdrawal.

Furthermore, some banks also offer loans against your fixed deposits to address the liquidity constraint. However, opting for this approach adds to your financial obligations.

5. Cannot Beat the Inflation:

Over time, the value of currency erodes due to inflation, leading to a decrease in its purchasing power. This implies that what you can currently purchase with a specific amount of money will cost more in the future due to the impact of inflation. Hence, it is advisable to assess the influence of inflation on investment returns. When considering investments in any financial instrument, it is essential to compute returns while factoring in the inflation rate.

For instance, if your fixed deposit is offering a 7% annual interest rate, and the inflation rate stands at 8%, your earnings may prove inadequate to counteract the inflation's effects, resulting in a decline in the real purchasing power of your money over the long term.

6. No Capital Appreciation:

Even though fixed deposits offer superior returns compared to savings accounts, they might not deliver returns that counteract inflation or facilitate wealth accumulation over the long term. Hence, to reach your financial objectives within a specified timeframe, it is crucial to diversify your investment portfolio in accordance with your risk tolerance, income, expenses, financial goals, and investment horizon.

While fixed deposits can be a viable investment choice, there exist various other low to medium-risk investment alternatives that have the potential to yield higher returns than fixed deposits, such as government bonds, debt funds, and debentures. By exploring a range of investment options and diversifying your portfolio, you can enhance the potential for increased returns and reduce overall risk.

7. Bank Defaults and Frauds:

While bank fixed deposits are commonly known as secure investment choices, there have been numerous historical cases in which banks failed to meet their payment obligations. The Deposit Insurance and Credit Guarantee Corporation (DICGC) is a subsidiary of the Reserve Bank of India (RBI) that provides insurance on deposits held by customers in a bank. As of February 04, 2020, the Bank Deposit Insurance covered under DICGC was raised to Rs 5 Lakhs from the earlier cover of Rs 1 Lakh. So, now you are insured for up to Rs 5 lakhs of bank deposit (principal interest). However, any amount exceeding this threshold is subject to potential default risk.

[Download Our Free Guide Now: How to Define Asset Allocation And Invest Smartly]

8. Reinvestment Risk:

When your bank fixed deposit reaches its maturity date, you can either receive the full payout or renew your deposit. Renewing the FD means that your deposit will be influenced by the current market interest rate. If the current rate happens to be low, renewing your bank fixed deposit could negatively impact your investment objectives.

9. Tax:

The interest generated from a fixed deposit falls into the category of 'Income from Other Sources' and is subject to taxation. As the interest from the fixed deposit is combined with your overall income and then subjected to taxation, the applicable tax rate depends on your income bracket. For example, if you fall within the 20% income tax bracket, the interest earned from the fixed deposit will also be taxed at a rate of 20%.

Furthermore, investors are also liable for TDS (Tax Deducted at Source), where the interest from the fixed deposit is disbursed after the deduction of taxes. The TDS rate for fixed deposit interest is 10% if you have furnished your PAN details; if not, the rate is 20%. The tax deduction on the interest earned from the fixed deposit ultimately reduces the returns you receive from your investment.

[Also Read: Is Fixed Deposit a Worthy Investment Option for You?]

To conclude:

These are some of the downsides associated with fixed deposits for the investors who are willing to take the moderate risk. Nevertheless, as discussed, despite these limitations, fixed deposits are one of the preferred instruments in the Indian investment landscape, especially among investors with no to low-risk appetite and senior citizens. Investing in a bank FD is a prudent choice if you are seeking an investment vehicle that provides guaranteed returns for the short or medium term with lower risk.

However, if you have a moderate to high-risk appetite, it may not make sense to rely solely on bank fixed deposits for fulfilling your long-term financial objectives due to the relatively lower interest rates associated with longer tenures. If you are ready to take moderate to high risk and aim to achieve your long-term goals, you may consider investing in carefully selected equity mutual funds.

Even for low-risk takers and senior citizens, there are several other investment options for long-term financial goals with a low to moderate level of risk. Liquid funds and debt funds are examples of alternative investment choices to bank FDs.

While investing in market-related instruments carries a level of risk, they also have the potential to yield significant returns over the long term. These mutual funds have demonstrated better performance in terms of delivering higher returns, offering professional management, and improved liquidity.

However, this doesn't imply that risk-takers should place all their savings in mutual funds. As discussed earlier, market-linked financial instruments, similar to fixed deposits, come with their own set of pros and cons.

Remember the adage, "Don't put all your eggs in one basket"? This principle remains valid in the realm of investing. Before allocating your funds to any financial instrument, it is imperative to establish a robust financial plan, define your investment objectives, evaluate your risk tolerance, and choose the appropriate mix of investment instruments. Hence, it is advisable to consult a financial expert who can assess your risk tolerance, income, financial goals, and other pertinent factors and provide guidance on your investment portfolio.

We are on Telegram! Join thousands of like-minded investors and our editors right now.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.