Fixed deposits have always been a popular option as it offers the advantage of assured returns and has low risk. There are broadly two types of fixed deposits, with one of the most known being those offered by banks which have low risk appetite.
While the other is corporate fixed deposits which offer higher interest but carry a lot of risk as compared to bank fixed deposits.
It has been observed that investors are very clear when it comes to returns on FDs, but the risks associated with FDs are still less clear. Hence, the article is based on a discussion on the risks associated with investing in fixed deposits:
liquidity risk
It is well known that fixed deposits facilitate the availability of funds, although not all fixed deposits have high liquidity. For example, a tax saver FD has a lock-in period of five years, due to which the investor cannot liquidate the fund before maturity.
Also, if a certain bank does not have online liquidation facility, one may have to visit the branch and do paperwork to withdraw funds from his or her fixed deposit.
default risk
There have been few cases of defaults by small co-operative banks, in such situations these investors are usually at risk of vulnerability. It is noted that under a new rule, investors can insure deposits up to Rs. 5 lakh per account but any amount above that is subject to default risk.
inflation risk
It is an untold truth that inflation affects every investment and thus increases risk. For example, if an FD gives 8% interest and the inflation rate is 6% at present, the actual return earned is only 2%. It is true that the interest on FD is fixed and has no effect on market volatility, but the actual returns increase or decrease according to inflation.
high taxation
Fixed deposit interest income can be fully taxable until you are above 60 years of age, where Rs. 50,000 is exempt under section 80TTB. Your interest income is clubbed with your income and taxed as per your slab.
So, if you are in the 30% tax slab, a 7% FD can effectively provide you only 4.9% returns which is further reduced by rising inflation.
reinvestment risk
To discuss this particular risk, let’s raise a question – What happens after the FD matures? Therefore, on maturity of the FD, the investor can choose between two options – either withdraw the money or extend the FD.
The investor can get a fresh FD but only at the rate that is applicable now. This can jeopardize your long-term financial goals as you cannot reinvest the money at an attractive rate of return.
Even though the article discusses the risks associated with fixed deposits, the investor should keep in mind that they are a great source of income when the amount is invested for long term purposes.
The risks associated with the scheme are still low as compared to other investment options. Therefore, investors must try to invest in this scheme with complete knowledge of the market and the scheme.
obey mintjini For more such stories.