Friday, January 31, 2014

Why Fixed Deposits (FD’s) are not good for You?

Fixed deposit or FD is one of the most popular financial products today. There are several reasons for its popularity more than just the returns offered. It is a very simple product to understand and invest. There is also a guarantee of the returns offered. What else would you want? Don’t you think this is the best place where you can put your money? If you do, just think again. Let’s list out 6 reasons why FD’s are not quite good for you.
Reason 1 – No Tax Benefits

Fixed deposits in general do not provide any tax benefits for you. Only the deposits of tenure above 5 years qualify for tax deduction under section 80C. Rarely does one opt for such longer tenure deposits. Moreover, these are unlike regular deposits and cannot be withdrawn. Sweep-in or overdrafts are also not allowed on such deposits. So the tax deduction that you intend to claim through these tax saving deposits come with some conditions. When there are so many instruments that can be used for deduction under section 80C, FD’s are not such a good choice for this purpose.

Reason 2 – Low Returns post tax

FD gives a return of around 9-10% p.a. For senior citizens, it is 0.5% more than the usual rate. However, have you ever considered its post tax returns? If you are in the 10% tax bracket, it may not make much of a difference to you. But, if you are in the higher tax brackets, your post tax return will come down drastically. The 9% return promised will become 7.2% and 6.3% for 20% and 30% tax brackets respectively. When you compare these returns with an inflation of over 10%, you know how good your investment has fared.

Reason 3 – Interest rate risk

When you are investing in a fixed deposit of 1 or 2 year tenure, you are locking your investment for 1 or 2 years. Once you withdraw your amount or renew the deposit, you should be looking at the interest rate prevailing at that point in time. There are many chances that you might get a lower interest rate than the one offered to you earlier. The rates are subject to volatility especially in this volatile interest rate scenario where RBI keeps changing interest rates on a constant basis.

Reason 4 – No Liquidity

The lock-in on your deposit also means that you would not be able to withdraw amount from your deposit till maturity. Compare it with a liquid fund which allows you to withdraw money in a span of 24-48 hours and the rest of the amount keeps receiving the interest.

Reason 5 – TDS on the interest

If you have taxable income, TDS will be deducted on the interest received from your fixed deposit. In general, it is not really bad as you have to pay tax on your income anyways. However, there are instances where TDS has been deducted despite you submission of form 15 G/H. There are also cases where banks misplace the PAN numbers and you would have to show various proofs in order to get it corrected. You would also have to apply for a refund of the TDS amount at the time of tax filing. People who have filed their taxes 6 months back are still waiting for their refund amount.

Reason 6 – Flexibility

I believe this is the major difference between an FD and a Mutual Fund. You do not have the flexibility of investing in phases in an FD, whereas in a Mutual Fund, you can invest via SIP/STP. You can choose your SIP amount and invest in it systematically and this amount can be as low as Rs. 500 or Rs.1000. This also introduces to you a concept called ‘Rupee Cost Averaging’.

Reason 7 – Withdrawal penalty

Fixed deposits can be withdrawn within the maturity date, but with some penalty. Penalty varies from bank to bank. It can be in the range of 1-2%. There is a specific formula for calculating the withdrawal penalty on breaking a fixed deposit. Such penalty might seem to be low but if the invested amount is in lakhs, this penalty would be a few thousands.

Final Word

These are some of the reasons why you should consider alternatives to fixed deposits for investing a lump sum amount. That does not mean FD is not a good investment. If your requirement suits it, you should go for it. It is better if you do a quick review of the above points before you pick it up. As a financial advisor, I suggest different debt funds offered by Mutual funds companies, FMPs, or you should go for Money Manager Fund with Reliance Any Time Money Card offered by RELIANCE MUTUAL FUND.

Source : investmentyogi

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