Know your fixed deposits in 5 simple steps

On the face of it, it does not get any simpler than investing in a fixed deposit (FD). FDs offer a fixed rate of interest over a fixed tenure. According to most investors, FDs are a safe bet because usually they do not default.
 
However, such a simplistic interpretation can prove costly for your finances.

There is no reason to underestimate FDs or consider it a tame investment not worth the time and effort for deeper analysis. Investing in FDs is like investing in any other investment. It requires careful study and informed decision-making.
 
Here are the 5 most critical points to consider before investing in a FD:
 
1. Credit profile
This is the all-important criterion while short-listing a FD. The pre-conceived notion that FDs honour their commitments is misplaced and very dangerous as many investors have learnt it the hard way. The issuing company’s credit profile determines whether they will be in a position to honour their financial commitments of making timely capital and interest payments. The credit profile is estimated by a rating agency, and the rating is featured prominently by the company.
 
2.  Interest rate
While the interest rate on an FD is determined by the general economic environment, the credit profile of the company also plays a part. A company with a ‘AAA’ credit profile will not offer the highest interest rate on its FD. This is because it is a relatively low risk investment and hence attracts investors on the certainty of timely payment of capital and interest rate payments. Companies with lower credit rating offer higher interest rates to compensate investors for higher risk.
 
3.  Post-tax return
A fundamental point to consider before making any investment is the post-tax return. The interest payout on your FD is subject to marginal rate of taxation which depends on your personal income tax slab. So even if a FD offers a very attractive rate of return you need to consider the post-tax return before committing money.
 
4.  Interest payout frequency
Most FDs offer multiple interest payout options viz. monthly, quarterly, annually or a one-time payment at maturity. Your financial needs dictate which interest payout option you should choose. If you are a retired individual you might prefer regular interest payout and opt for a monthly/quarterly option. Other investors might opt for the cumulative option because they don’t need the money in a hurry.
 
5.  Tenure
Companies offer a range of tenures on their FDs varying from a few months to several years. Your decision on the FD tenure is dictated by your need for liquidity like a financial obligation you must honour over a specific time horizon. For instance, if you have surplus funds towards a down payment on a home loan, opt for a FD with a tenure that coincides with the timing of the down payment. It’s all about matching your tenure with your financial obligations.
 
Evidently there is more to an FD than just a fixed interest rate over a fixed tenure. Some easy and basic decisions can make your FD investment a lot more rewarding.