What To Consider When Investing In Fixed Deposits

Investors in fixed deposits have several positive factors going for them. They also need a clear strategy.

<div class="paragraphs"><p>(Source: Unsplash)</p></div>
(Source: Unsplash)

Investors in fixed deposits have several positive factors going for them. Interest rates offered by banks have climbed, plus banks are putting in additional efforts to lure them with special offers. In the midst of all this, having a specific strategy for every part of your investment is a sound move, and this applies to fixed deposits too. This will lead to better decision-making and result in the achievement of the targeted financial goals.

Here are some factors to consider while framing the strategy:

 Understand The Market Conditions

Market conditions differ when it comes to every asset class, and this is no different for fixed deposits. There are various phases in the cycle for fixed deposits, and this fluctuates between a period of upswing, when interest rates are moving higher, and a downswing, where rates are falling or even expected to fall further. The investor will be able to take action based on the correct identification of the stage in the cycle. At the present moment, the upcycle is on for fixed deposits, and it is also close to its peak because interest rates have risen significantly and are not expected to go up much more. This would form the basis of the exposure that would be considered by the investor.

Real Rates Matter

One of the most important goals for an investor is to look for a real rate of return for their fixed deposit investments. A real rate of return means that the earnings should be greater than the inflation rate. This is not easy to achieve because the future inflation rate cannot be predicted, and persistently high inflation can throw the entire calculation off track. It could be that the current rate that one is getting is higher than inflation, but in the future and till the end of the deposit period, this might not sustain. Hence, the goal for the investor should be to ensure that they are getting a positive real rate of return, and at the same time, there is also a margin left so that some future rise in inflation is also taken care of.

 Consider Your Tax Situation

Interest earned on fixed deposits is taxable as interest from other sources. There is a tax deduction at source when the interest exceeds Rs 40,000 in a year for an individual, but the limit for tax deduction at source goes up to Rs 5 lakh if the tax payer is a senior citizen. If a senior citizen is under the old tax regime, then they will get a deduction of Rs 50,000 from the interest that they earn on the fixed deposits. So in effect, this income, up to the deduction limit, becomes tax-free for the senior citizen. This is a factor that needs to be considered, as the tax rate applicable to the income determines the net return earned at the end of the day.

Special Period Deposits

Instead of deciding beforehand the time period for which the money for a fixed deposit is going to be invested, it might also help if one has some flexibility present. This is because one can make use of special period deposits, which are fixed deposits for specific time periods. Banks are looking to raise large amounts of funds to finance their lending, and hence they are introducing special period deposits that can be longer in terms of time, like 555 days, 666 days, or 729 days, and they are giving higher rates for such deposits. The investor can make use of these deposits and make their earnings higher, so it is something to watch out for.

Understand The Annual Interest Rate

There is a need for the investor to know the exact rate of return that they are earning for a correct comparison. So, they need to look at the annual rate of interest and then position it with respect to the time period of their deposits. If the deposit is for more than a year, then the earnings will be at this rate for each year. If the deposit is for less than a year, then the actual earning will be lower in absolute terms, depending on the time period of the deposit, but when annualised, the return will come to the mentioned percentage. This key concept will enable one to make the right choice among the options that are present.

The writer is the founder of Moneyeduschool.