Bank fixed deposits (FDs) are back in vogue. Considered as the investment pariahs for the greater part of the last four years as interest rates were headed down.
But, with the equity market turning volatile, and rising interest rates have made these instruments attractive now. No wonder, they are playing an increasingly important role in the asset allocation spectrum.
However, interest rates of 9.5, 10, 10.5 per cent for 512 days, 369 days etc are being flashed in billboards all over the country enticing investors to rush in. Here are few things you should know about bank FDs.
All fixed deposits are not "safe" investments -- It is generally assumed that every rupee invested in FDs is guaranteed by the government. Sadly, this is not true. Only a total of Rs 1 lakh (Rs 100,000) worth of funds per depositor is guaranteed.
This includes the sum total of monies lying in the savings bank account plus those in fixed deposits.
Also, only those banks who contribute to the Deposit Insurance and Guarantee Credit Corporation are eligible to receive this protection.
Generally, it is safer to park your money in scheduled banks rather than non-scheduled banks. Do not get swayed by the juicy interest rates offered by unknown co-operative banks as these may not even be on the list of Reserve Bank of India's list of scheduled banks.
Look at interest rates closely: This is a very elementary piece of information but there are many educated people who overlook the fact that the interest rate quoted is the rate per annum.
For instance, if a bank announces that the interest rate on a six month FD is 10 per annum, it actually means 10 per cent a year. In other words, Rs 100 invested in this FD will grow to Rs 105 only over six months and not to Rs 110. Also when banks offer say, 8.5 per cent for 390 days, the interest rate per annum would work out to 7.95 per cent. So it is best that you do not get confused.
Do not ignore the tax angle: Post-tax returns are the returns which actually accrue to you. Hence always compare the post-tax returns of competing instruments.
For instance, if you are in the highest tax bracket, the dividend option of a quarterly Fixed Maturity Plan (FMP) will be superior to a three month bank FD, because dividends earned by the investor will attract a Dividend Distribution Tax of just over 14 per cent while he will have to pay tax at the rate of over 30 per cent on the interest earned on the FD.
On the other hand, if you are in the lowest tax bracket of 10 per cent, the FD will prove to be a superior investment as compared to the FMP.
Gauge the exit options first: Today, many banks are offering attractive interest rates on FDs of one year and above. Look before you leap before blocking your money in these deposits.
First of all, only invest that money which you can really set aside for the entire tenure. For instance, in case you have to pay regular equated monthly instalments (EMIs) on your home loan, you cannot afford to block that sum in a one-year FD.
What happens in case you want to prematurely withdraw your money? In this case, you will get the prevailing interest rate for the time period that your money was locked into the deposit, and in some cases, there would be a penalty of one per cent.
For instance, if you withdraw a one year deposit after six months, then the bank will pay you the rate prevailing on a six month FD when you invested in the deposit (which usually will be lower than the one year FD). So go ahead and deploy your funds into bank FDs but do so only after doing your homework well.
The writer is a certified financial planner.
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