Once upon a time, there was an old lady who believed in the importance of saving money. She knew how useful savings are and how a certain preserved amount for the future purpose could come to her aid, whenever she would need it the most. The old lady was good at saving money despite a lack of formal financial education. Whenever she saved ample money, she'd go to the bank and ask them to put in whatever scheme yields regular interest. The bank would ask her how long she wanted to put the money, and she would say whatever period pays the highest interest. She didn't understand what she was asking for, but she knew what she wanted.
Money is generally put aside in a bank for savings purposes and to generate interest income regularly. However, since the old lady wanted to save her money for future contingencies, she put her saved cash in fixed deposits (FD) with the bank. Under a fixed deposit account, the lady could now only withdraw the amount after a fixed tenure, during which she would generate some additional interest on her initial amount. After the FD's maturity, the lady would get her initial saved amount along with the additional interest she had earned.
So, what is this fixed deposit, and how did it become a secure source of savings for the old lady?
Fixed deposits are investment schemes offered by banks and NBFCs wherein investors put (deposit) their idle money in exchange for guaranteed fixed returns at maturity. The returns (in the form of interest) from fixed deposits are usually higher than those of a savings bank account.
So, how does this system work?
What happens essentially is that you lock your money (principal) for a fixed time (tenure). Interest is earned on this principal amount throughout the tenure on a cumulative basis. It keeps getting added to the principal amount after specific intervals.
At the end of the fixed period (at maturity), principal plus accumulated interest amounts are paid back to the investor. The primary rule here is that if money is withdrawn before maturity, the investor may be required to pay the penalty.
The tenure of fixed deposits can range from 7 days to 10 years (20 years in some cases). The rate of interest varies from banks to banks. The interest rates for senior citizens are usually 0.25% to 0.65% higher than the standard rates.
A fixed deposit can be opened with a bank where you have an existing savings account. However, banks let you open fixed deposit accounts even if you don't have a savings account with them. For this, you must present relevant documents like proof of ID and address, and photographs as a part of a KYC process.
The following entities can make a Fixed Deposit investment in India:
- Resident Indian individuals – including minors, senior citizens, and joint investors
- Hindu Undivided Family (HUF)
- Companies, partnership firms, sole proprietorships
- Trusts, clubs, societies, and other association of persons
- Non-resident Indians (NRIs)
This is a non-exhaustive list and varies from bank to bank.
- Proof of identity: PAN card, Aadhar card, voter ID, driver's license, ration card, senior citizen ID card, etc.
- Proof of address: Utility bills (electricity/telephone/water), photocopy of the bank statement with a cheque, etc.
- Offline: Visiting the nearest branch office of the bank where you wish to open the fixed deposit account, with the requisite documents and an official at the bank, who will guide you through the process.
- Online: Download the application from the bank's website where you wish to open the fixed deposit account. You may be required to register with the bank before applying.
Normal/Standard Fixed Deposits:
These are primary investment vehicles wherein an investor invests an amount (principal) with a bank. On maturity, the investor is paid back the amount plus accumulated interest. Interest rates on such fixed deposits are usually higher than regular savings accounts.
Senior Citizen's Fixed Deposits:
These fixed deposits apply to individuals over the age of 60 years. The interest rates on such deposits are 0.25% to 0.65% higher than the standard rates.
Tax-saving Fixed Deposits:
These fixed deposits are availed for the primary purpose of tax savings. Depositors can avail of tax exemption on the deposition of principal amount up to Rs. 1.5 lakhs in a calendar year. There is a lock-in period of 5 years, i.e., you cannot withdraw the principal before five years are up.
Cumulative Fixed Deposits:
These are fixed deposits where the interest is compounded at regular intervals (quarterly, half-yearly, or yearly). These fixed deposits help to grow investor earnings substantially. Pensioners benefit significantly from these deposits.
Flexi Fixed Deposits Plans:
These fixed deposit accounts are linked to your savings bank accounts, and the money shuffles between the two accounts. Investors can maintain sound liquidity and enjoy higher interest rate returns from these fixed deposit plans.
Fixed Deposits for NRIs:
NRIs can avail of the fixed deposit benefits in India through either of the following ways:
NRO Fixed Deposit Account
NRE Fixed Deposit Account
- NRIs can deposit their earnings in India in an NRO fixed deposit account.
- The entire amount of interest earned and a certain amount of the principal deposited can be repatriated by the NRO account holders.
- NRIs can deposit their earnings from abroad in an NRE fixed deposit account.
- The NRE account holders can repatriate the entire amount of interest earned, and the principal deposited.
Investing in fixed deposits comes with its advantages, some of which are listed below:
- Quick and easy liquidity: Fixed deposits can be easily liquidated in times of emergencies.
- Regular source of income: The depositors, as per their requirements, can have the interest credited to their accounts on a monthly, quarterly, or annual basis.
- Tax benefits: Investments in tax-savings fixed deposits can fetch tax exemption of up to Rs. 1.5 lakhs in a financial year.
- Benefits to senior citizens: Senior citizens enjoy a higher interest rate than the standard fixed deposit holders.
- Risk reduction: The returns on fixed deposits are not affected by market fluctuations, and therefore fixed deposit investments help lower the risk in a diversified portfolio.
- Deposit Insurance: The depositors are insured for a sum of Rs. 1 lakh / Rs. 5 lakhs against bank defaults, i.e., the bank's inability to make payments.
- Loans against fixed deposits: Loans of up to 90% of the principal amount deposited can be availed at lower interest rates. Tenure of such loans is limited to the fixed deposit's maturity period against which such a loan is availed.
Despite their numerous benefits, fixed deposits suffer from certain limitations. Some of these limitations are as follows:
- Fixed interest incomes: The interest rate on fixed deposits is not restated according to the inflationary conditions, making fixed deposit investments unfavourable for investors trying to beat inflation.
- Penalties on early withdrawals: The principal amount of deposit is locked in for the deposit tenure. Any premature withdrawal attracts penalties and additional charges.
- Limited tax benefits: The tax benefits of fixed deposits can be availed when investments are made in tax-saving fixed deposits.
The eligibility criteria for investing in fixed deposit (as discussed earlier) is pretty broad, and everyone can invest in fixed deposit schemes. However, the following people invest more in fixed deposits:
- Inexperienced investors: Investors with little to no knowledge of the financial markets can easily invest in fixed deposit schemes to reap its benefits.
- Risk-averse investors: Investors who are reluctant to make risky investments, and prefer preservation of their capital, benefit significantly from fixed deposit investments.
Whether you are an amateur investor (like the old lady) or a seasoned investor looking to manage the risk of a diversified portfolio, fixed deposits will always provide a safe avenue to reap easy and regular income. So what are you thinking about?
Go on, invest that idle money on your hands in a fixed deposit!