Checklist for a ‘smart’ FD investor

Fixed deposits (FDs) remain one of the most preferred investment options for earning steady returns while ensuring the safety of principal. However, the extent of capital protection can vary depending on the type of bank/financial institution, while the rate of returns would additionally depend on the FD tenure, payout option and renewal mode chosen by the depositor.

Here are some of the crucial factors that depositors should know for optimum FD investment decisions.

Safety of Capital

The actual degree of capital safety on opening FDs with banks depends on whether the bank is covered under the deposit insurance program of DICGC, a wholly owned subsidiary of the Reserve Bank of India (RBI). The program covers cumulative deposits (including savings, fixed, recurring and current deposits) of up to ₹5 lakh maintained by each depositor of each covered bank, in the same right and same capacity, in case of a bank failure. At present, every commercial bank in India and cooperative banks, except for primary cooperative societies, are covered under this insurance program.

Note that FDs opened with NBFCs are not covered under this deposit insurance scheme.

Interest Rates

Interest rates of FDs differ widely depending on the issuing bank/NBFCs and their FD tenures. Currently, the highest FD slab rates offered by small finance banks are about 100-150 basis points higher than those offered by public sector banks and large private sector banks.

As deposits opened with small finance banks are covered under the DICGC insurance scheme, investors aiming for higher returns while seeking maximum capital safety can distribute their high-yield FDs across multiple banks in such a way that the total deposits held with each bank, under the same right and capacity, do not exceed ₹5 lakh.

Optimum Tenure

When selecting their FD tenures, depositors should factor in their liquidity requirements and the time horizon of their financial goals. Ignoring these factors can lead depositors to make premature FD withdrawals to deal with financial emergencies or to meet their overlooked financial goals. Premature closure of FDs can incur a penalty of up to 1% on the effective interest rate, which is usually the lower of the originally contracted rate or the rate applicable for the period for which the FD remained with the bank, at the time of booking the FD.

Depositors should also factor in the FD slab rates and the interest rate trend, if possible, while selecting their FD tenures.

Interest Payment Options

Depositors can choose between two main types of fixed deposits — cumulative and non-cumulative — based on how they wish to receive the credit of their interest income.

In case of non-cumulative FDs, interest is paid out at predetermined intervals, usually at monthly and quarterly payout intervals. However, some banks/NBFCs also offer half-yearly or annual interest payout options. In the case of cumulative FDs, the accrued interest income is reinvested, allowing them to earn interest on their own.

Renewal Option

Most banks provide an auto-renewal option while opening fixed deposits, wherein the principal and interest component (in case of cumulative FDs) are automatically reinvested into a new FD on the maturity date for the same tenure but at the prevailing interest rate for that tenure. Depositors who do not opt for the auto-renewal option have their FD maturity proceeds directly credited to their linked savings/current account.

(The writer is CEO of Paisabazaar)