Fixed deposits, also known as FDs, have always been a preferred safe haven for many investors who seek safe avenues for their savings. Fixed deposits provide fixed returns over a specified period, which can range from one year to a decade.
While long-term FDs come with their own set of advantages and disadvantages, understanding both sides can significantly help investors make informed financial decisions.
In this blog, we will delve into the pros and cons of long-term fixed deposits.
Advantages of Long-Term Fixed Deposits
So, what are fixed deposits? A fixed deposit is a type of investment where an investor makes a lump sum deposit to a bank and receives interest at a certain rate for a predetermined amount of time. An FD with a fixed period of time, ranging from 1 year to 10 years, is called a long-term fixed deposit.
There are several advantages of long-term fixed deposits. Some of them are discussed below:
Fixed Returns
The guarantee of fixed returns provided by long-term fixed deposits is one of the most outstanding aspects of Long Term Fixed Deposits.
The fixed deposit’s interest rates are fixed and not impacted by changes in the market. For example, if an investor invests their money in a long-term FD at an FD interest rate of 6.5% for five years, he will get this interest rate throughout the 5 years, giving them predictable income on their investment.
Higher Interest Rates Compared to Savings Accounts
Long-term fixed deposits generally offer higher interest rates as compared to regular savings accounts. For example, a standard savings account may yield an interest of 3-4 % annually, whereas long-term FDs often yield a 5.5-7.5% FD interest rate on deposits.
Financial Discipline
Committing funds to a long-term FD fosters better financial discipline in investors. Locking in money for an extended period prevents people from spending in the heat of the moment.
One of the attractive aspects of FDs is that they can be helpful for investors with strong impulses to spend, and act as a well-defined savings plan for them.
Loan Facilities
Investors can take loans against their fixed deposits. Using this feature an individual can use his investment as collateral and get a loan at a more favorable rate of interest as compared to a personal loan.
For example, if an investor has a fixed deposit of ₹1,00,000, they can secure a loan up to 80% of their fixed deposit.
Tax Benefits Under Section 80C
In India, fixed deposits with a lock-in term of five years or more are eligible for tax deductions under Section 80C of the Income Tax Act.
In Section 80C of the Income Tax Act maximum deduction of ₹1.5 lakh is allowed per individual. This tax-saving feature enhances the attractiveness of long-term fixed deposits, allowing investors to earn interest while simultaneously reducing their taxable income.
Disadvantages of Long-Term Fixed Deposits
There are several disadvantages of long-term fixed deposits. Some of them are discussed below:
Reduced Liquidity
One notable drawback of long-term fixed deposits is their inherent lack of liquidity. Once funds are committed at FD rates for a fixed duration, it is challenging to access those funds until maturity.
In situations of financial emergencies, premature withdrawals are possible but they are often accompanied by penalties and interest loss.
Inflation Risk
Fixed deposits may not always keep pace with inflation, despite their guarantee of returns. The real returns on a fixed deposit may also decrease over time due to the volatility of inflation rates.
For example, if your FD gives a 5% interest rate and inflation is 6%, you are technically losing money in terms of purchasing power.
Interest Rate Rigidity
Long-term fixed deposits lock investors’ money at a predetermined interest rate for a specified term. If market interest rates rise after a deposit is made, investors are often left at a disadvantage.
For example, if an investor initially locked interest rates on fixed deposits at 6% for five years, and the market rate increases to 8% within a year, then they miss out on the opportunity for greater earnings.
Tax Implications on Interest Earnings
Interest earned on fixed deposits is taxable, which can diminish the overall returns of the investment. It is categorized as “Income from Other Sources” and is taxed according to the investor’s income tax bracket.
Limited Growth Potential
Long-term fixed deposits have limited growth potential when compared to riskier assets like stocks or mutual funds. For instance, if an investor commits a considerable portion of their portfolio to fixed deposits, he may miss opportunities for capital appreciation provided by equities or real estate, which historically deliver higher returns over extended periods.
Conclusion
Long-term fixed deposits present a mix of appealing benefits, alongside significant drawbacks. Ultimately, incorporating fixed deposits into a diversified investment strategy can offer stability and predictable income. However, it is essential to weigh their limitations against potential growth opportunities in other asset classes.
By making informed decisions, investors can harness the advantages of long-term fixed deposits while strategically positioning themselves to achieve their long-term financial goals.
