Know How Does A Fixed Deposit Work?

Bank fixed deposits still remain one of the most preferred investment options for Indians. Here, we look at how FDs work and what are the pros and cons of the same.

Fixed deposit is one of the most popular investment tools in India as they offer guaranteed returns and are risk-free. Investors can park their money in fixed deposits as per their financial needs as fixed deposits offer investors the flexibility of choosing the tenure of investment. Such deposits offer the highest flexibility to the investor in terms of the investment amount, tenure of investment and interest payouts. Various banks and other financial institutions in India offer investment schemes at competitive fixed deposit interest rates.

How does a fixed deposit work?

Fixed deposit is a traditional investment tool preferred by investors who are looking for a secure investment option and regular income flow. As the name suggests, fixed deposit offers fixed returns on the investments. The nature of this investment is very secure and they earn interest as per the interest rate they carry. Following are certain pre-determined parameters on which they work:

The rate of interest offered by the banks and financial institutions are pre-determined. Investors are made aware of the interest rates that the bank will offer on their investment even before the time of investment.
The rate of interest is determined and dependent on the tenure and amount of investment. A usual trend is that higher the investment period, higher is the interest rate.
Usually, most of the banks and financial institutions offer a higher rate of interest to their senior citizen investors.
Banks and financial institutions usually curate and offer fixed deposit scheme as per the needs and requirements of their investors, like tax saver fixed deposits
Investors have a choice to choose interest payout frequency as per their financial needs. All banks and financial institutions offer different interest payout frequency for the convenience of their investor.
Investors have the flexibility to choose the tenure of the fixed deposit as per their convenience. An investor can choose any tenure ranging from 7 days up to 10 years.

How fixed deposit help in saving money?

The bank deposits are one of the most sought investment tools because of its unique feature. Following are the distinct features offered by bank deposit that help you in saving money:

Investing in bank deposit is very quick and simple.
It offers an opportunity to earn extra by means of earning interest on investment.
It is one of the most secure and risk-free investment tools, thus attracting investments from conservative investors.
Fixed deposit as an investment instrument promotes and is responsible for creating perpetual savings habit in the minds of the investor Since it does not encourage premature withdrawal of invested money, investors are encouraged to save a lot of money for longer tenure i.e. till the date of maturity.
The instrument offers higher liquidity by way of loan or overdraft facility
Fixed deposit offers higher returns as compared to interest received on savings or current account - in this manner investors can earn extra money
If an investor opts for monthly mode of interest payout then it can act as a perpetual source of income
Fixed deposit interest rates for senior citizen are higher thus; it is the best form of investment tool for them.
The instrument offers a nomination facility to the investor i.e. the investor can nominate an individual of his or her choice. In case of the untimely death of the investor, the bank or financial institution shall pay the interest amount to the nominee
Investors can also avail credit card against their fixed deposit investments

Pros and Cons of investing in Fixed Deposits

Pros

No Risk: Fixed deposit receipt have no risk associated with them, as they have no connection with the stock market. So, the market fluctuations and volatility do not hamper the performance of this instrument. Irrespective of the market fluctuation, the investor of fixed deposit shall receive the interest as per the pre-determined conditions offered by the bank or financial institutions
Liquidity: Emergencies or financial crisis can occur at any moment in life. At such situations, fixed deposit instrument provides financial support to overcome such situations. In the event of financial crises, investors can choose to either dissolve the instrument or can avail loan facility. In both cases, the investor shall receive financial support within minutes. Hence, it is a very strong and handy investment option in times of financial crisis.
Flexible: one of the most important advantages of fixed deposit is that it offers maximum flexibility to the investors in terms of tenure and interest payouts. Every investor can plan their financial portfolio in such a manner that they can receive interest payouts as per their financial requirements. Similarly, having fixed deposit of varied tenure shall be helpful in overcoming the financial needs arising at various stages of life.
Higher returns: Fixed deposit interest rates offered by various banks are higher than other bank products, like a savings account and current account. Therefore, in case any investor has an extra sum of money kept in these accounts then it is best recommended to invest it in bank fixed deposit, as it will guarantee higher returns. Similarly, the bank fixed deposits in India offer a higher rate of interest to the senior citizen, so any investor can make the most of their investment by taking advantage of this facility.

Cons

Conservative: Even though it is the safest investment instrument, it is important to note that the nature of this instrument is very conservative. The returns earned under fixed deposit instrument are lesser as compared to most of the other market linked investment options available in the market
Penalty: While the instrument provides financial support and is one of the most liquid investment tools, but most of them come with certain penalty charges. Every fixed deposit comes with a pre-determined tenure, but if an investor wishes to liquidate the invested amount partially or dissolve the complete amount then the investor has to bear the penalty charges i.e. pre-withdrawal charges which can be heavy incase the invested amount is huge.
Tax Benefit: Not all fixed deposit offers tax benefits. There are only a few FD schemes that offer tax benefit called as tax saver FDs. Additionally, it is important to note that in case of joint ownership of fixed deposit, only the first owner of the instrument is eligible for tax benefit facility as per the terms of the Income Tax Act.

How to decide the average amount and lock-in period for your fixed deposit?

Investing in fixed deposit is a good investment decision but it is best to first understand and determine the personal financial aspirations and then make investments. The average amount and lock-in period can be determined after assessing personal financial needs. The investors can decide the amount of investment as per their investment portfolio and financial needs. Lastly, we recommend all investors to carry extensive market research and then invest.