Last Updated on September 26, 2023 12: 01am
Investments play a significant role in your financial growth. You can choose from many investment avenues, but they also carry some risk. The risk can be low in some but high in others, making it crucial for you to choose avenues as per your risk tolerance.
Ready for a challenge? Click here to take our quiz and show off your knowledge!
One commonly preferred investment vehicle is a fixed deposit. As an investment instrument, its risk-level is comparatively lower. In addition, when you choose FD schemes from issuers offering some of the highest fixed deposit interest rates, you can maximise your returns.
However, whether you invest in a PNB Housing Finance FD or an FD from any other well-known issuer, you take on some inherent risks that can result in low growth. To make a well-informed decision, consider these risks against the benefits of FDs.
Read on to know some of the risks associated with fixed deposit investments and tips to minimise the risks.
Ready for a challenge? Click here to take our quiz and show off your knowledge!
Underperformance Against Inflation
Inflation lowers the value of your money and, as such, is a significant factor that can help assess if your investment is moving in the right direction. When it comes to FDs, you can quickly understand this by checking the interest rate.
If it is higher than the inflation rate, staying invested is ideal. However, if that is not the case, it is likely that there may not be any real growth for your corpus. As such, you should not simply choose an FD with the highest interest rate but rather compare it with the inflation rate.
For example, say you invest in PNB Housing Finance FD at an interest rate of 8.71% per annum, and the inflation rate is around 7%. This means your investment will grow at a rate higher than inflation, making it a good choice.
Default or Bankruptcy Risk
Although it happens rarely, financial institutions may default at the time of FD maturity. This means you will not get the funds you invested and earned, which can translate into a major loss. As such, this is another significant risk you should consider before investing.
However, it is also important to note that if you invest in a bank FD, your investment will be protected by the DICGC. For corporate FDs, you can look at their credibility rating to understand whether the FD returns are likely to be stable and secure.
Possibility of Higher Taxation
The interest you earn from fixed deposits is subject to taxation. So, if you choose the highest fixed deposit interest rate, you face a higher tax liability. Remember, the interest earned is subject to TDS only if you earn more than ?40,000 in a financial year. This limit extends to ?50,000 for senior citizen investors.
If your interest earned exceeds these thresholds, the issuer will deduct TDS. You can submit a self-declaration form 15G/H to avoid this if your income is lower than the taxable amount. In any case, remember that the interest payout is taxed as per your tax slab.
So, while you can use an FD calculator to forecast your returns, make sure you time your deposit to minimise your tax liability.
Varied Liquidity Costs
Fixed deposits are not only low-risk avenues but also liquid. You can make a premature withdrawal and get instant access to funds. However, this liquidity comes at a cost, which varies depending on your issuer, the FD type, and the terms.
Most issuers lower your interest rate, affecting your overall earnings, and levy a penalty charge for the withdrawal. The drop in interest can be between 0.50%-1.00%, depending on your issuer, and the penalty charge will also be as per the issuer’s policy.
These costs are also subject to change during your investment tenor. So, if you make a premature withdrawal, you may have to bear a higher cost, which can lower your overall earnings.
Opportunity Cost
In fixed deposits, there are two types of interest risks. The first one is the underperformance against inflation, which was discussed above. The second one is that the interest rate may increase during the tenor of your investment.
This is a risk because FDs have fixed interest rates. This means that once you book an FD, the interest rate will not change, meaning you may not get to leverage the future increase. As such, even if you book the highest fixed deposit interest rate, you risk missing out on even better rates and returns.
Reinvestment Risk
In fixed deposits, you have the option to reinvest your maturity amount. However, you may not get the original interest rate but rather the prevailing interest rate of that time. So, if the rates go down, you may be unable to capitalise fully from your investment.
The best way to navigate this is to check the interest rate trends and predictions before investing. You should consider reinvesting only if you can get the same, if not better returns. So, if you invest in the PNB Housing Finance FD and the interest rate at maturity is lower than your previous rate, you should avoid reinvesting.
Tips to Minimise the Risk of FD Investments
- Choose a company FD with the highest credibility rating
- Diversify your investment portfolio with avenues in different asset classes and risk levels
- Reinvest only after assessing the market trends and your financial requirements
- Go for the issuer offering the highest fixed deposit interest rate and security
- Assess the market trends and gauge future movements to invest at the right time
- Consider creating an FD ladder for enhanced liquidity and optimised returns
- Look for options that lower your tax liability, like tax-saver FDs
- Evaluate your future needs and goals to invest strategically
- Split your deposits between multiple banks and NBFCs
Armed with the above information, compare the FDs from the different issuers. This will allow you to choose the highest fixed deposit interest rate and optimise your investment to secure better returns. To compare your earnings, use the FD interest calculator available online.
This easy-to-use tool estimates your maturity amount and total interest earned in just a few clicks. This facilitates quick, simple, and easy comparison, enabling you to choose the right FD and secure good returns.