Five tips for investing in fixed deposits
It may be a good time to open a fixed deposit and lock in at high levels before the interest rate cycle turns. ET Wealth lists out the key things you need to know before investing in these fixed income options.
1. FDs are not entirely safe
Don't think your money is completely safe when you invest in a fixed deposit. While corporate deposits are unsecured loans that do not guarantee anything to the investor, in case of banks, the Deposit Insurance and Credit Guarantee Corporation (DICGC) insures deposits of up to Rs 1 lakh per customer across all branches of a bank.
So, if you have Rs 3 lakh to invest, split it into 3-4 investments across different banks. While this will safeguard your money, an added advantage is that if you need the amount in case of an emergency, you won't have to break the entire deposit. This means that you will have to pay the premature withdrawal penalty only for the sum that you need, even as the rest of the money keeps growing.
2. Ladder your investments
Spreading your investments across different banks controls the default risk, but what about the risk of locking in your money for long periods at low rates? Fixed deposits are prone to uncertainty because interest rates tend to move in multi-year cycles. To avoid this, build a ladder of fixed deposits which have different tenures.
If you have Rs4 lakh to invest, split the amount in four deposits of Rs1 lakh each for one, two, three and four years. When the 1-year deposit matures, reinvest the maturity proceeds in the 4-year FD. By doing so, the highs and lows in interest rates will balance out over a period of time. This will also ensure liquidity because you will have one deposit maturing every year.
3. Premature withdrawals invite a penalty
Make sure you get the tenure right while investing in a fixed deposit. Locking up money for the long term and then making a premature withdrawal means lower returns. If your bank is offering a 9% interest on a one-year deposit, and 9.5% for a 5-year term, don't be tempted to go for the longer term if there is a possibility that you may need the money earlier.
If you opt for the 5-year fixed deposit and then break it after one year, you will get the rate applicable to the one-year deposit. Worse, you may be slapped with a premature withdrawal penalty that will lower the rate by 1 percentage point. So, instead of gaining half a percentage point, you may end up losing 1 percentage point. To avoid this, go for the ladder system mentioned earlier.
4. TDS is only an interim tax
The interest earned on your FD is fully taxable. If the interest amount exceeds Rs 10,000 in a year, the bank or corporate house will deduct 10.3% tax at source before you get the amount. Your tax liability doesn't end here. If you are in the higher income bracket (annual income of over Rs 5 lakh), you will have to pay more tax on this income.
1. FDs are not entirely safe
Don't think your money is completely safe when you invest in a fixed deposit. While corporate deposits are unsecured loans that do not guarantee anything to the investor, in case of banks, the Deposit Insurance and Credit Guarantee Corporation (DICGC) insures deposits of up to Rs 1 lakh per customer across all branches of a bank.
So, if you have Rs 3 lakh to invest, split it into 3-4 investments across different banks. While this will safeguard your money, an added advantage is that if you need the amount in case of an emergency, you won't have to break the entire deposit. This means that you will have to pay the premature withdrawal penalty only for the sum that you need, even as the rest of the money keeps growing.
2. Ladder your investments
Spreading your investments across different banks controls the default risk, but what about the risk of locking in your money for long periods at low rates? Fixed deposits are prone to uncertainty because interest rates tend to move in multi-year cycles. To avoid this, build a ladder of fixed deposits which have different tenures.
If you have Rs4 lakh to invest, split the amount in four deposits of Rs1 lakh each for one, two, three and four years. When the 1-year deposit matures, reinvest the maturity proceeds in the 4-year FD. By doing so, the highs and lows in interest rates will balance out over a period of time. This will also ensure liquidity because you will have one deposit maturing every year.
3. Premature withdrawals invite a penalty
Make sure you get the tenure right while investing in a fixed deposit. Locking up money for the long term and then making a premature withdrawal means lower returns. If your bank is offering a 9% interest on a one-year deposit, and 9.5% for a 5-year term, don't be tempted to go for the longer term if there is a possibility that you may need the money earlier.
If you opt for the 5-year fixed deposit and then break it after one year, you will get the rate applicable to the one-year deposit. Worse, you may be slapped with a premature withdrawal penalty that will lower the rate by 1 percentage point. So, instead of gaining half a percentage point, you may end up losing 1 percentage point. To avoid this, go for the ladder system mentioned earlier.
4. TDS is only an interim tax
The interest earned on your FD is fully taxable. If the interest amount exceeds Rs 10,000 in a year, the bank or corporate house will deduct 10.3% tax at source before you get the amount. Your tax liability doesn't end here. If you are in the higher income bracket (annual income of over Rs 5 lakh), you will have to pay more tax on this income.
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