Fixed deposits (FDs) of banks are an important component of many investors' portfolio. In fact, many investors bet purely on these instruments for steady returns. But, one has to be careful because a single-minded focus on FDs can lead to a situation which might not be in the best interest of an individual.
The most important question that an investor needs to answer is the tenure of the deposit. This is because, based on this criteria, an investor has to choose a deposit that will give best return.
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There are few observations to make as far as the tenure goes. One might have to do some forecasting, in terms of the interest rate direction, overall situation of the economy and how things could change in the coming days.
Even a little analysis might lead to a conclusion that products that provide the highest rate might not be the best bet.
Highest rate scenario
One of the common ways for investors to put their fixed deposits is to simply look at the rate chart of banks and then decide which scheme pays the highest rate. And if the investor thinks that there is nothing to lose because he is getting the best rate on offer, he can opt for it. This is the simplest way of going about the entire process. But, while this is true for the short run, things might not be the same over the longer term. For a longer period, an investor needs to look at things differently.
Many banks are witnessing a slow growth in their loan book and at the same time, they do not want to pay a higher interest rate for a long period. Their best interest rates might be seen for short-term deposits.
Latest data from the Reserve Bank of India show term banks' deposits of up to five years and above have fallen from 18.6 per cent at the end of March 2014 to 5.9 per cent at the end of March, 2015.
If you ask your banker for deposits with higher return, they are most likely to guide you to take one with one to three years' time period. Rates for short-term deposits are equal or more than rates for the longer period. In Bank of Baroda, for example, every deposit for a period over a year till 10 years has the same rate of 6.75 per cent.
In State Bank of India, fixed deposits from 456 days to three years have the highest rate of 7.25 per cent while those beyond three years are at seven per cent. In HDFC Bank, which is a big private sector player, every deposit above one year till 10 years has the same rate of 7.25 per cent.
In such a scenario, investors should try and go for the longest time period that they can put the deposit for because this will meet their long-term need and ensure that they do not have to worry about a fall in the interest rate during the tenure. Benefits of this will be seen over multiple years. Here are some of the reasons why choosing a longer time period will benefit investors.
Assured income
The biggest incentive for an investor in going in for a fixed deposit is that they want an assured flow of income over a period of time. If a person has locked himself into a long-term fixed deposit of ,say, eight years because it is suitable for their particular needs, there is not going to be any tension as far as the income flow from this investment is concerned.
Since the deposit is locked in, there is no worry if interest rates were to fall.
If the deposit is for a shorter time period, say one year, then at the end of this period the investor has to worry whether he will get a similar rate after maturity. By locking in for the longer time period, such problem would not occur.
Trending rates
The way things are going in the Indian economy at the moment, it looks like the structural problem of inflation is coming slowly under control and this would mean that the interest rates in the economy will keep trending downwards. While this will take some time to play out, when the trajectory is clear, it means interest rates on fixed income instruments will also come down further. If this happens, any deposit that matures in the near future would earn a lower rate if reinvested in the future, thereby bringing down the overall returns of the portfolio.
More importantly, if rates stay low in future, a need would arise to re-evaluate the role of fixed deposits in the portfolio of many investors. This is the reason why investors should first try and ensure that their fixed deposits are locked in for the maximum time period possible so that they remain relatively less impacted from this trend, which is likely to play out over the medium term. While it is not possible to protect oneself against the trend, the impact can be minimised.
Monitor your investments
Any investment that is held for the longer time period has to be monitored. This is same with fixed deposits. Things that need to be done include timely renewals, proper tracking and even rolling over at the right time.
Efforts increase in case of short-term deposits because an eye has to be kept on them constantly so that when the time comes, the necessary effort needs to be made for renewing them. In addition, if someone has to submit Form 15G/H, this would need to be tackled as well.
The writer is a certified financial planner
