Any investment portfolio should comprise the right mix of safe, moderate and risky investments. While mutual funds and stocks are the favorite contenders for moderate and risky investments, fixed deposits, government bonds etc. are considered safe investments. Fixed deposits have been particularly popular among a large section of investors in India as a safe investment option for a long period.
A fixed deposit account allows you to deposit your money for a set period of time, thereby earning you a higher rate of interest in return. The longer the investment period, the better the interest rate will be. The banks provide interest rates depending on this loan amount and the tenure of deposit. Fixed deposits also give you a higher rate of interest than a savings bank account.
Here are the benefits, drawbacks of fixed deposits and precautions one should take while making such investments.
Benefits
1. Safety
The fixed deposits of reputed banks and financial institutions regulated by RBI (Reserve Bank of India) the banking regulator in India are very secure and considered as one of the safest investment methods.
2. Regular Income
Fixed deposits earn fixed interest rates for their entire tenure, which is usually compounded quarterly. So, those who want an income on a regular basis can invest into fixed deposits and use the interest rate as their income. This makes a fixed deposit very popular way of investing money for retirees.
3. Saves tax
With the directives of the income tax department stating that investment in fixed deposits up to a maximum of Rs.100,000 for 5 years are eligible for tax deductions under section 80 C of income tax act, fixed deposits have again become popular. Fixed deposits save tax and give high returns on invested money.
Drawbacks
1. Lower rate of returns
While the money invested in stock markets may give you a return of 20% the fixed deposits will yield only about 10%. So, the money grows slowly in the case of fixed deposits.
2. Taxes
The interest earned on fixed deposits is fully taxable and is added to the annual income of the individual. Gains from stocks are considered capital gains while dividends are tax free.
3. Rising inflation can wipe out the interest benefits.
The actual benefits or income from fixed deposit can be annulled by a rising inflation. Suppose the inflation which is currently at 3 % rises to about 6%, your fixed deposit at 10% annual return will effectively yield only(10%-6%) = 4% of return. This return would have been (10% -3%) = 7% if the rate of inflation had not changed. This can drastically eat into your fixed deposit income.
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