MC explains: Why smaller FDs work better than one large FD

In their quest for convenience, investors often end up forgoing many other benefits. Take the case of fixed deposits. Some investors prefer one fixed deposit of a large value of, say, Rs 10 lakh or Rs 25 lakh in one bank. Though this means they need to have just one fixed deposit receipt, it deprives them of other benefits.

Here is why you should have multiple fixed deposits — instead of one FD of Rs 25 lakh, for instance, it would be better to have five of Rs 5 lakh each.

Diversification

Having multiple FDs lets you invest across issuers. Even if one of the issuers goes down, the impact may be restricted to that extent. This is especially useful if you are investing in the fixed deposit of a bank or a company with a relatively low credit rating.

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In the past, depositors in PMC Bank, Yes Bank and Kapol co-operative Bank (Kapol), among others, faced turbulence. Kapol is still in a moratorium (restrictions on business activities).

Investing across issuers can help you tap relatively better opportunities available beyond your bank. If you choose to keep all your money in one bank in a fixed deposit then you cannot, for instance, benefit from the higher rate of interest offered by other institutions.

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Deposit insurance covers deposits up to Rs 5 lakh per investor, per bank. This should be noted when you are making large deposits. However, this aspect may have limited appeal for investors restricting themselves to nationalised banks or postal schemes.

Reinvestment risk

When you have only one large FD receipt, on the date of maturity, you will have limited scope to look around for better rates. If the interest rates in the economy are low at that moment, then you will be forced to invest all your money at that level. For example, between May 2020 and February 2022, the rate of interest on bank fixed deposits was low, as policy rates had been lowered to infuse liquidity and revive the economy by Reserve Bank of India. If you had invested in an FD at that time, you would have been investing at those low levels.

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Investing your money across tenures — one, two, three and five years, depending on your cashflow requirements — helps you spread the maturities over a period of time. This may save you from the risk of reinvesting all your money at a low rate. Even if one of the FDs matures in a low rate regime and you have to roll it over at a low rate, the other FDs keep earning a higher rate of interest.

You can now Invest in Fixed Deposits on Moneycontrol app.

Liquidity

Though one may plan well and have an emergency fund in place, sometimes large financial emergencies call for liquidation of financial assets. In such cases, breaking a large FD means you face a premature withdrawal penalty on the entire amount. Also the remaining amount has to be invested at the interest rates prevailing then.

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For example, an individual may need Rs 2 lakh, and if he breaks a fixed deposit of Rs 25 lakh, he will have to redeploy the remaining Rs 23 lakh at the current rate, which may be lower than what he was already earning on the FD. But if he has five FDs of Rs 5 lakh each, then he can simply break one FD and address his financial needs comfortably. The remaining FDs will be untouched and keep interest. He can also choose to reinvest Rs 3 lakh from the FD that he ended prematurely, at the current rate.