Fixed deposits have, since forever, been one of the most preferred investment vehicles for a lot of people in our country. Whether as the sole warrior of a risk averse investor¡¯s portfolio or a part of a balanced portfolio of a risk taking investor, more often than not fixed deposits turn out to be a safe haven and default choice. This is thanks to their twin features of income certainty and capital protection.
However, with the economy witnessing falling interest rate regime since past few years or so, bank FD rates have dropped and stayed low. So it's natural to ask yourself the question - Does it make sense to invest in an FD anymore? And with the stock market booming to all time highs, and the rising?awareness surrounding the immense potential of mutual fund, investors have been looking the other way. This has been evident from the significant jumps in number of mutual fund investors added and the assets under management for mutual fund houses, which rose 12% in FY 2020-21 vs FY 2019-20 and doubled in the past five years, from Sept¡¯ 2016 to Sept¡¯ 2021, respectively.?
The primary reason behind escalations in mutual fund investments can be attributed to the fact that they not only have something to offer for varying risk appetites and investment horizons of investors, but even their returns tend to mostly outperform the sub-optimal returns of fixed income instruments like Bank FD or PPF by good margins, especially over the long term, after factoring in factors like inflation and taxation.
So, let¡¯s deep dive into what works in favour and against FD investments, and find out how they weigh against other popular investment options like mutual funds and PPF.?
The DICGC (Deposit Insurance and Credit Guarantee Corporation), a subsidiary of RBI, offers deposit insurance cover for deposits opened with scheduled banks. The cumulative bank deposits, which include fixed deposits, savings account, recurring deposits and current account are insured upto Rs 5 lakh per bank per depositor in the event of bank failures. Both the interest and principal component of FDs along with deposits held in savings and current accounts, are insured under DICGC.?
FD investors who are new to credit, I.e. do not have any credit history and hence no credit score, can leverage their FD to avail secured credit cards. These cards are offered against collateral of FD, and the depositor continues to earn interest on the FD used as collateral. With features just like regular credit cards, barring the pledging of FD, disciplined usage and repayment of secured credit cards can help in building or improving one¡¯s credit score and therefore, boost eligibility for availing a regular credit card and loans in future. Secured cards can especially be helpful for those facing difficulty in getting regular credit cards due to reasons like no or low credit score, inadequate income, unserviceable location, employer¡¯s profile or job profile.?
Almost all banks offering FD provide the facility of loan against FD, in the form of overdraft facility. In this, a credit limit is sanctioned to the borrower based on the amount of FD pledged as collateral, and the interest is levied only on the amount drawn, until it¡¯s repayment is done. But fret not, your pledged FD continues to earn interest during the loan tenure. Moreover, Taking loan against FD allows you mitigate financial shortfalls without having to close that FD prematurely and incurring the applicable prepayment charges.
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Five year tax-saver bank FDs offer the benefit of availing tax deductions up to Rs 1.5 lakh per financial year under Section 80C of Income tax act. However, the interest earned on these will also be taxed according to your tax slab, which will reduce your post-tax returns.
Unforeseen emergencies or overlooked financial goals can propel you to withdraw your bank FD prematurely, which may lead? to incurring a premature withdrawal penalty of usually around 1%. The penal rate is deducted from the effective rate of interest, which is generally the lower of original card rate or the card FD rate for the period the deposit has been in effect.?
Tax liability of FD investors does not end with TDS deduction done by banks. The entire interest income on your FD is added to your annual income and taxed as per the depositor¡¯s tax slab, making the post tax returns of bank FDs much lower especially for those failing in the higher tax slabs. The difference between the actual tax liability and TDS amount deducted gets adjusted at the time of filing income tax returns.?
Let's have a look at how current Bank FD returns fare against the like of PPF, debt and equity mutual funds:
3 month returns
Bank FD -?2.75%-4.25%
PPF -?7.1% p.a. (reviewed by Finance Ministry in every quarter of a financial year)
Debt Mutual Funds (Category average range for categories) - 0.76%-3.86%
Equity Mutual Funds (Category average range for all categories) - 2.13%-22.74%
1 year returns
Bank FD - 4.50%-6.25%
PPF - 7.1% p.a. (reviewed by Finance Ministry in every quarter of a financial year)
Debt Mutual Funds (Category average range for categories) - 2.79%-9.89%
Equity Mutual Funds (Category average range for all categories) - 30.57%-97.03%
3 year returns
Bank FD -?5.15%-7%
PPF - 7.1% p.a. (reviewed by Finance Ministry in every quarter of a financial year)
Debt Mutual Funds (Category average range for categories) - 2.82%-10.51%
Equity Mutual Funds (Category average range for all categories) - 14.17%-37.28%
5 year returns
Bank FD -?5.25%-6.75%
PPF - 7.1% p.a. (reviewed by Finance Ministry in every quarter of a financial year)
Debt Mutual Funds (Category average range for categories) - 3.66%-7.91%
Equity Mutual Funds (Category average range for all categories) - 7.78%-29.87%
(Indicative Broad range of FD rates currently offered by largest banks (in terms of market capitalisation)- SBI,HDFC,ICICI,Axis and Kotak Mahindra Bank; and highest FD rates offered by Small Finance Banks. Debt and equity mutual fund returns as on 13.10.2021 (direct plans) sourced from valueresearch.)
Despite the capital protection and certainty of income being the twin key features of Bank FDs, it's vital to weigh their pros and cons before zeroing in on any decision. As the primary aim of investing your hard earned money is wealth creation, remember that FD returns, at least in present scenario, fall behind many investment options like PPF and mutual funds by a significant margin, especially the post tax returns. Moreover, with the economy currently witnessing a falling interest rate regime, it does not make sense to lock in your FDs at such low interest rates, especially for long term. By not locking your FD at present low rates, you keep the door open for considering investing later at higher FD rates when the interest-rate cycle turns and rises. However, keep in mind the discussed pros and cons before investing in FDs, and compare their pre and post tax returns with other investment instruments like mutual funds. In all likelihood, mutual funds are expected to outperform bank FDs by good margins and help in wealth creation and achievement of financial goals in life.
For those jumping into FDs for tax benefits, the tax deduction of up to Rs 1.5 lakh under Section 80C offered by five year bank FD is offered by both PPF and Tax saving mutual funds (ELSS) as well. Whereas for the taxability of returns, PPF¡¯s returns are not taxable as PPF falls into the EEE category (invested amount, interest earned and maturity value are all tax free). Taxation of mutual funds is done as - Short term gains (when investment is redeemed within 3 years) of debt mutual funds are taxed as per your income tax slab. Whereas long term gains (when investment is redeemed after 3 years) on your debt fund units attract a tax rate of 20% after indexation. And for equity funds, 15% rate of tax is levied on short term capital gains(when investment is redeem within 1 year), whereas long term capital gains (when investment is redeemed after 1 year) get taxed at 10% (only for gains above Rs 1 lakh in a financial year).
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