Earlier this week, HDFC Bank and the Bajaj Finance, a non-banking financial company (NBFC), have increased their fixed deposit (FD) rates for select tenures. The hikes have come a week before the Reserve Bank of India’s (RBI) monetary policy review. For example, for FDs for a three-five-year period, HDFC Bank is offering an interest rate of 5.35 per cent. For five to 10 years, it is 5.50 per cent.
Should You Invest?
While FD rates are going up, you should know a few things before deciding to invest in them. “FDs offer high security and good liquidity, but in today’s low-interest, high-inflation scenario, the real returns are negative,” says Adhil Shetty, CEO, BankBazaar.com.
The Real Rate Of Return: It is important to understand that the real returns on FDs are a lot less than the rate of interest. To arrive at the real rate of return, you need to factor in the taxes and inflation.
“Your real return from an FD is the actual return after accounting for income tax. The category returns for one-year (forward-looking) fixed deposits today are 4-6 per cent depending on which bank you choose. Hence, your post-tax returns on low-risk instruments are 4.20 per cent on the fixed deposit. At 6-7 per cent inflation, your real returns amount to -1.8 per cent to -2.8 per cent,” says Shetty.
The Taxation Bite: The bank estimates your interest income for the year from all the FDs you have with the bank. If your interest income exceeds Rs 40,000 (Rs 50,000 in the case of senior citizens), the bank will deduct 10 per cent as TDS. However, the interest income gets added to your income, and you would need to pay taxes according to the income tax slab applicable to you.
Note that the tax on the interest accrued in one year has to be paid in the same year. For instance, if you have a cumulative FD, the interest is paid out at the end of the term. However, interest accrues every quarter. So, tax will be calculated on the interest accrued in one financial year and not on maturity of the FD.
Moreover, if you withdraw money from an FD before the tenure gets over, the lender will charge a penalty, reducing your returns.
The Alternatives
Your time horizon plays a very important role in the investment that you choose. For a longer-term horizon of five years or more, equities remain the best bet. But for a shorter tenure, you may need to consider other options if you are dissatisfied with the real returns from FDs.
“A better alternative of a fixed deposit is a debt fund,” says Anant Ladha, founder, Invest Aaj For Kal, a financial planning firm. The biggest benefit of a debt fund is the indexation benefit. Indexation refers to recalculating the purchase price, after adjusting for the inflation index. Since the purchase price is adjusted for inflation, the capital gain gets reduced and effectively increase your real returns.
When comparing returns of FDs to liquid funds, one should understand that a liquid fund is basically a parking fund. “In terms of returns, FD returns is absolutely fixed and in liquid fund it is equal to the yield minus the expense ratio and subject to duration risk, if any. Usually, liquid fund gives 1 per cent higher returns than savings bank accounts and almost equal to what an FD gives. Liquid fund, in the true sense, is an alternative for savings bank accounts. If we talk about taxation, FDs are taxed according to tax slab which is the same for capital gains on liquid funds below three years. If held for more than three years, it becomes long term and gets indexation benefit,” says Ladha.
“To sum up, If you need your money in probably the next few months or may be a year, then FD can be a good option. But if you are investing your long-term money in FD, then inflation will end up eating into the returns,” adds Ladha.
