When is it okay to break my fixed deposit?

A FEW decades ago, countless Indians would dream of becoming a lakhpati. Today, with so many finance products on the horizon, this dream has gotten ambitious: they want to become nothing less than a crorepati! However, many of us still park most of our money in Fixed Deposits (FDs). Is this a good idea?

FDs, still a hot favourite

The market is flooded with investment products that yield good returns. But investors still prefer traditional options like bank FDs. The reason: security and guaranteed returns. Recent studies indicate that more than 80 to 85 per cent of invested money is parked in post office savings or FDs.

The comfort zone

A safe and secured investment like a bank deposit can give you psychological comfort. But is it a good option in the long term? Not really. Though FDs offer interest rates of up to 8 to 9 per cent, people tend to forget about tax and inflation. Here's an example. You invest Rs 100 in a bank deposit and it yields an interest of 9 per cent per annum. When it matures, you pay a 30 per cent tax on it.

After a year, your net worth will be Rs 106.30, which means your effective return is just 6.3 per cent. In the mean time, the value of goods and services has increased, immensely, due to inflation. This means you have literally achieved nothing!

So, how do you make more money?

Break the FD, pay back your loan!

Many people repay loans and simultaneously invest in bank deposits. It's not prudent to do this. Note: This excludes home loans because it yields a tax benefit. Hence, the rate works out, lower.

So, though a home loan and a fixed deposit is fine, all other loans like personal loans and credit card debt should be paid back immediately by breaking your FD. Here's the logic.

The personal loan is a debt trap

They charge an interest rate of between 12 and 16 per cent. Credit card loans are even more expensive at the rate of 36 to 50 per cent. Hence, it is unwise to earn 8 to 9 per cent returns an FD, whilst you are paying 2 to 16 per cent on your loan. Since the interest earned on an FD is taxable, it turns out to be an even bigger mistake!

If you have a personal loan of Rs 10 lakh at the rate of 14 per cent interest per annum, for one year, then your Equated Monthly Installment (EMI) works out to Rs 89,787. You may also have an FD of Rs 10 lakh, which yields a 9 per cent rate of interest.

Let's assume that the highest tax bracket applies to you.

� Option 1: Keep the FD and also repay the loan separately.
� Option 2: Repay the loan by breaking the FD. Then invest Rs 89,797 in an FD every month (you would have paid this as an EMI every month).

In Option 1, your net interest outgo is Rs 14,445, while in the second option you earn a net interest of Rs 31,111. Thus, effectively you will lose, Rs 45,557 if you choose psychological comfort over financial prudence. Even if the loan were available at 9 per cent (the same as your FD rate) you still be lose about Rs16,720.

My advice: Work towards attaining psychological financial freedom!

- Sanjay Matai is a personal finance advisor ( www.wealtharchitects.in ) and author. ' Millionaires don't eat cakes...they make them ' is his latest publication.

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