Fixed deposits, also known as term deposits, are financial instruments that allow investors to park their funds for a fixed period of time and earn a fixed rate of interest. They are a popular investment option for risk-averse investors who want to earn a stable return on their investment.
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In this article, we will explore the ins and outs of fixed deposits ( FD ), including how they work, the pros and cons of investing in them, and how to choose the best fixed deposit for your needs.
What is a Fixed Deposit?
A fixed deposit ( FD ) is a type of investment where an investor deposits a lump sum of money for a fixed period of time, ranging from a few months to several years, with a financial institution such as a bank or a credit union. The investor earns a fixed rate of interest on their deposit, which is typically higher than the interest rate offered on a regular savings account.
The interest rate offered on fixed deposits depends on various factors, including the duration of the deposit, the amount of money deposited, and the prevailing market conditions. Generally, the longer the duration of the deposit, the higher the interest rate offered.
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Fixed deposits are a low-risk investment option since the principal amount and the interest earned are guaranteed by the financial institution. This means that even if the market conditions change or the financial institution faces financial troubles, the investor will still receive their principal amount and the interest earned.
How do Fixed Deposits Work?
To invest in a fixed deposit, an investor needs to have a savings account with a financial institution. The investor needs to fill out a fixed deposit application form and provide the necessary documents, such as identity proof and address proof, to open a fixed deposit account.
The investor needs to specify the amount of money they want to deposit, the duration of the deposit, and the interest payment frequency (monthly, quarterly, half-yearly, or yearly). Once the deposit is made, the financial institution offers a fixed rate of interest on the deposit, which remains the same throughout the duration of the deposit.
At the end of the deposit tenure, the investor can either withdraw the principal amount and the interest earned or reinvest the amount in a new fixed deposit.
Pros and Cons of Fixed Deposits :-
Like any investment option, fixed deposits have their pros and cons. Let's take a closer look at them.
Pros:
Low risk: Fixed deposits are a low-risk investment option since the principal amount and the interest earned are guaranteed by the financial institution.
Guaranteed returns: The interest rate offered on fixed deposits is fixed and guaranteed, which means that the investor knows exactly how much they will earn on their investment.
High liquidity: Fixed deposits offer high liquidity, which means that the investor can withdraw the principal amount and the interest earned at any time, subject to certain conditions.
Easy to open: Fixed deposits are easy to open and do not require a large investment amount. Most financial institutions offer online fixed deposit facilities, making it easy for investors to invest from the comfort of their homes.
Cons:
Low returns: The interest rate offered on fixed deposits is typically lower than the returns offered by other investment options such as stocks and mutual funds.
Fixed duration: The investor needs to lock in their funds for a fixed duration, which means that they cannot withdraw the funds before the maturity date without incurring penalties.
Inflation risk: Fixed deposits offer a fixed rate of interest, which may not keep pace with inflation. This means that the investor may end up earning a negative real rate of return on their investment.
Taxation: The interest earned on fixed deposits is taxable as per the investor's income tax slab, which can reduce the overall returns