Thursday, March 5, 2015

What is an FD?


Most of you must have heard the word FD. Let us understand what it means and how it affects our investments.

·         FD is short for ‘Fixed Deposit’. In India it is called ‘Fixed Deposit’ or a ‘Term Deposit’. It is called Term Deposit in New Zealand, Australia, and Canada, or a ‘Certificate of Deposit’ (CD in USA).

·         A Fixed Deposit is a financial instrument for investment. As the word suggests, a Fixed Deposit is fixed in nature, i.e. you are depositing your money for a fixed length of time and at a fixed rate of interest.

·         Banks accept Fixed Deposits and some companies too accept them. Generally the interest rates issued by Companies are higher than those given by Banks. Similarly, the interest rates given by private banks and Co-operative banks will be higher than Nationalised banks.

·         A Fixed Deposit is a Bond. The Bank or the Company who accepts the Fixed Deposit from an investor, issues a receipt for the same.

On the receipt are mentioned:
     Name of the Bank / company
     Investor’s name and address
     Nominee’s name
     PAN card number of the investor
     Deposit number
     Period of deposit
     Date of maturity
     Maturity amount
     Annualized yield (p.a) or Rate of Interest – 8. 5% etc.
     Interest frequency – Quarterly etc.

·         At the end of the time period of deposit, the original investment amount plus the interest will be returned to the investor.

Simple Calculation to show the interest received for a Fixed Deposit:
A.     For an initial deposit of Rs.10,000,
At the Rate of interest of 8.5% and
If time period for which the investment is made is 1 yr., and
Interest compounded Quarterly,
Amount received at the end of 1 yr. will be Rs.10,877
At the end of 1 year, Rs.10,000 becomes Rs.10,877. ie. an increase of Rs.877 on the initial investment.

Looks good, right?

Is it the actual case?

No.

·         Because, there is something called TDS or Tax deducted at source. All banks & companies deduct tax before returning your money, if the interest exceeds Rs.10,000 (as per SBI).
Take for example, TDS is 20%. On Rs.877, the tax deducted is Rs.175.40. You will only receive Rs.10,701.60.

Supposing Inflation is at 5.1%. It means, that Inflation eats into the interest earned on the Fixed deposit. Effectively, your Rs.10,000 one year back, invested at the rate of 8.5% interest is worth only Rs.10,191.60 today.
If the interest rate is lower than 8.5%, you can imagine how much you will be earning on your Rs.10,000!

Not very inspiring and motivating, is it?

So, should you invest your money in a fixed deposit for an effective 1.91% interest per year?

Yes and No.

·         If there is a requirement for cash in the next few years, then it is prudent to hold the money in Fixed deposits. On the other hand, if you don’t need cash in the next few years, and you can invest for the long term, it is wise to consider other financial investment options which give better returns.

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