There’s a certain comfort that comes with the phrase ‘fixed deposit.’ It’s predictable, reliable, and safe. Yet, is this respected investment vehicle really the golden goose many believe it to be?
This article delves into the Disadvantages of Fixed Deposits and the reasons you might want to steer clear.
Can fixed deposits genuinely deliver value in a world of escalating inflation rates and dynamic economic landscapes? Or are there alternative investment avenues that can better serve your financial aspirations?
We’ll debunk common myths, unravel the difficulties, and expose the potential pitfalls of this seemingly safe harbour.
Get ready to see fixed deposits in a whole new light.
How Fixed Deposit Works?
A fixed deposit is a savings or investment account provided by banks and financial institutions. Customers deposit a specific sum for a predetermined period, called the term. In return, they earn higher interest than regular savings accounts.
At maturity, the customer receives the initial deposit plus accrued interest. Fixed deposits have minimum requirements and higher rates for longer terms.
Early withdrawals may attract penalties. They offer a low-risk option to save money and gain better returns on savings. Now let’s find out some disadvantages of fixed deposits.
8 Disadvantages of Fixed Deposits
While bank fixed deposits (FDs) are generally considered safe with a high likelihood of returns, they can have negative impacts on long-term savings.
Many of you wonder, is FD a good investment? No, Fixed deposits come with many drawbacks that investors should consider.
Here are some Disadvantages of fixed deposits one should consider before investing:
1. Lower Returns
Fixed deposits offer lower returns compared to riskier investments like stocks or real estate, making them less attractive for investors seeking higher profits.
While they provide security, the conservative nature of fixed deposits limits their potential to generate substantial wealth.
In periods of inflation, returns may not keep up with rising costs, decreasing the real worth of money. Thus, investors seeking stronger growth frequently search elsewhere for better returns.
A prudent decision to diversify could be to explore Where to Invest Money to Get Good Returns in India – 7 Investment Tips & Future-Focused Options, for potentially higher earnings.
2. Taxable Interest
Taxable interest is one of the biggest disadvantages of fixed deposit investment. The interest earned from a fixed deposit is categorised as ‘Income from Other Sources’ and is taxable for investors.
The applicable tax rate depends on the individual’s income slab rate. For example, if one falls under the 20% income tax bracket, the FD interest will also be taxed at 20%.
Additionally, investors are subject to TDS (Tax Deducted at Source), where the interest is paid out after deducting tax. TDS rates are 10% with PAN details and 20% without PAN. This tax component reduces the overall returns on the FD investment.
3. Fixed Tenures
Fixed tenures in fixed deposits refer to the predetermined period during which the investment remains locked, and the depositor cannot withdraw the funds without penalties or loss of interest.
The tenure is agreed upon at the time of deposit, typically ranging from a few months to several years, and the money remains invested for the entire duration.
This lack of liquidity can be a disadvantage, as investors may not access their funds until the maturity date, potentially limiting their flexibility in handling financial emergencies or taking advantage of better investment opportunities.
4. Inflation Risk
For investments to be effective, the post-tax returns should surpass the current inflation rate. However, fixed deposit interest rates often fall below the inflation rate.
To illustrate, with an inflation rate of 6.8% and a 10% income tax bracket, the FD rate should be 7.7% or higher to outpace inflation after taxes.
Investing in fixed deposits without inflation-beating returns is unwise as the earnings won’t keep up with rising living costs, eroding the actual value of the investment over time. Seeking higher-yielding options is crucial to combat inflation and preserve purchasing power.
5. Minimal Liquidity
A fixed deposit is less liquid compared to other investments as the funds are locked until the tenure ends. In emergencies, accessing money can be challenging.
Some banks offer premature withdrawal options, allowing early liquidation, but these may come with penalties.
Alternatively, some banks offer loans against FDs, providing liquidity but with added interest burden.
Overall, while fixed deposits provide safety and guaranteed returns, the lack of liquidity can be a disadvantage, and options like premature withdrawal or loans against FDs come with their own trade-offs.
6. Not Good for Long-Term Investment
Bank FDs are suitable for short-term savings but not ideal for long-term wealth creation. Instruments like PPF, VPF, and NPS offer tax-free returns, making them more advantageous.
Additionally, certain mutual funds have a track record of providing better long-term returns. However, investing in mutual funds requires caution and advice from certified financial advisors to manage risks effectively.
While bank FDs offer safety and liquidity, other investment options with tax benefits and higher potential returns are more suitable for long-term financial goals.
Given the limited potential of fixed deposits, understanding the 16 Best Low Risk Investments With High Returns In India 2023 can help diversify and enhance your portfolio.
7. Penalty on Premature Withdrawal
The premature withdrawal feature on fixed deposits can be beneficial, but it comes with a cost. Banks typically impose a penalty for early withdrawal, ranging from 1% to 3% of the accumulated interest. The higher the interest earned, the larger the penalty.
For instance, withdrawing a ₹1 lakh FD after one year at a 10% interest rate with a 1% penalty would result in a loss of around ₹100 from the interest.
While seemingly small, the impact can be more significant with higher interest rates, making premature withdrawal less attractive for investors seeking to maximise their returns.
8. Lack of diversification
Lack of diversification in fixed deposits means putting all your money into this low-risk investment, potentially leading to an imbalanced portfolio.
A lack of diversification can increase overall risk since you’re not spreading investments across various asset classes.
Diversifying across stocks, bonds, real estate, and other instruments can help mitigate risk and enhance the potential for better returns over the long term.
Here’s a concise table summarising the disadvantages of fixed deposits:
|Return on Investment||Fixed deposits offer lower returns compared to riskier assets like stocks or real estate. During inflation, the real worth of the returns can decrease.|
|Tax Implication||Interest earned on fixed deposits is taxable and subject to TDS (Tax Deducted at Source), which reduces the overall returns.|
|Tenure of Investment||Fixed deposits have a fixed tenure during which the investment is locked, limiting the flexibility of the investor in case of financial emergencies or better investment opportunities.|
|Inflation Risk||The interest rates of fixed deposits often fall below the inflation rate, causing the actual value of the investment to decrease over time.|
|Liquidity||Fixed deposits have minimal liquidity, as funds are locked in until the tenure ends. Premature withdrawal options often come with penalties.|
|Long-term Wealth Creation||Fixed deposits are not ideal for long-term wealth creation as other investment options like PPF, VPF, NPS, or certain mutual funds often offer better returns and tax benefits.|
|Premature Withdrawal Penalties||Banks impose a penalty for the premature withdrawal of the deposit, leading to a decrease in the overall returns.|
|Diversification||Investing solely in fixed deposits can lead to an imbalanced portfolio. Diversification across various asset classes can mitigate risk and potentially enhance returns.|
Why are fixed deposits considered disadvantageous?
Fixed deposits offer lower returns compared to other investment options, resulting in diminished wealth growth over time.
Is there any risk associated with fixed deposits?
Although relatively safe, fixed deposits do carry the risk of inflation eroding the purchasing power of your savings.
Can I access my funds before the maturity period ends?
Generally, withdrawing funds before maturity leads to penalties and reduced interest earnings, limiting flexibility.
Are fixed deposits affected by changes in the economy?
Yes, fixed deposit returns can be negatively impacted by fluctuating interest rates, affecting overall earnings.
Are there better alternatives to fixed deposits for higher returns?
Yes, exploring diversified investment options like stocks, mutual funds, or sustainable investments can offer potentially higher yields.
While fixed deposits have long been considered a safe investment option, they come with their fair share of disadvantages. The low returns fail to keep up with inflation, resulting in diminished purchasing power over time.
Additionally, the locked-in period restricts access to funds when unexpected needs arise. Moreover, with changing economic landscapes, the opportunity cost of not exploring potentially higher-yielding investment avenues cannot be ignored.
As forward-thinking investors, it is crucial to diversify and explore other options that offer better returns and flexibility.
Considering the limitations of fixed deposits, a significant diversification move could be to delve into the Best Green Investment Opportunities Available in India, merging profitability with environmental responsibility.
Embrace sustainable investments and make informed choices with SustVest for a brighter and greener financial future.
Founder of Sustvest
Hardik completed his B.Tech from BITS Pilani. Keeping the current global scenario, the growth of renewable energy in mind, and people looking for investment opportunities in mind he founded SustVest ( formerly, Solar Grid X ) in 2018. This venture led him to achieve the ‘Emerging Fintech Talent of the Year in MENA region ‘ in October 2019.