Everyone who has a bank account has invested in Fixed Deposits (FDs); FDs sell like hot cakes. It is the easiest instrument to understand and so everybody gets one. But apart from FDs there are other, better and wiser choices you can make. Let us learn more about FDs and find out what better alternatives are available.
About Fixed Deposits:
Interest on FDs: FDs earn a guaranteed interest rate for a fixed period of time. 1 year FD interest rates are currently in the range of 7% to 8%p.a. For 5 years, the interest rates range between 7.5% to 8.5%p.a.
Penalty on early withdrawal: If you break a FD, you have to pay a penalty – your interest is reduced by up to 1%. You have to pay income tax on the interest you earned on the FD.
Tax on FD interest: If you earn more than Rs.10,000 FD interest, then the bank will deduct tax at the rate of 10%. Irrespective of whether the bank deducts tax or not, you have to add the FD interest to your total income and pay income tax on it.
Tax saving FDs: Did you know that you have to pay interest even on the 5 year Tax Saving FDs as well? When you make tax saving FDs, the invested amount is tax deductible only for that year. The interest earned is taxable as per the prevalent tax slabs.
Pros of investing in FDs:
-Your parents will be proud of you and think that you are responsible and grown up.
-FDs are really easy to understand. Actually there is nothing to understand – even your kid brother could do it.
Cons of investing in FDs:
-There is no flexibility, you have to pay the penalty if you withdraw for any emergencies.
-The interest rates you earn depend upon the time horizon. This means that if you invest the money in a 3 month FD you earn 6.5% and for a 1 year FD you earn 7.5%.
26 year old Shikha Gupta learnt about an alternative to FD. Shikha Gupta, from Jamshedpur, now works with a well known IT firm in Bangalore. She has a very good pay package and has saved up Rs.40,000 to invest. Her parents suggested FDs as the right place to invest but her friend Stephen Mathew who was a financial analyst had a different view. Stephen suggested that she should invest in Debt Mutual Funds.
Of course, Shika had not heard of such a thing and was eager to know more. Stephen helped her understand more. He told her:
- You can save taxes by investing in debt funds, because after 3 years you get indexation benefits. Whereas in FDs you have to always add the interest earned to your total income and pay taxes.
- A good mutual fund can help you earn higher returns than the fixed interest on FDs. FDs interest rates are fixed over a period of time but debt fund returns move on a daily basis.
- There are different kinds of debt funds and you can pick what suits you best.
|Category||Time Horizon||Average returns over|
|Gilt Funds: Medium Risk||At least 5 years||5 years: 10.26%|
|Long Term Debt Funds: Medium Risk||At least 3 years||3 years: 9.32%|
|Dynamic Bond Fund: Medium Risk||At least 3 years||3 years: 10.08%|
|Ultra-Short Term Funds: Low Risk||Up to 1 year||1 year : 8.59%|
|Liquid Funds: Low Risk||3 – 6 months||6 months: 3.3%|
- Incase of emergencies, you can withdraw from debt funds. They have very minimal or no penalty in most cases. In case of long-term debt funds, the penalty is only for the first year. Whereas in FDs, all premature withdrawal has a penalty.
So where do you think Shika finally decided to put her hard earned savings?
You guessed it right – Debt Mutual Funds. Initially her parents did not understand her decision, but when Shika explained it to them, they were impressed with her mature decisions. Her father too, put some of his savings into debt funds instead of FDs.
If you want flexibility, better tax benefits and the ability to earn higher returns, debt funds would be your best choice.
So now are you ready to make a smart investing choice like Shika?
For more such useful articles read our blog.
About FinMitra: finmitra.com is a robo-advisory platform where you can get personalized investment recommendations plus effortless, online investing. Finmitra team consists of IIM and SP Jain alumni who are finance experts with several decades of experience.
Reach me on email@example.com for more finance gyan or simply to chat.