Fixed deposits are very popular among many of you because they are risk-free investment avenues. The rate of interest is fixed for the tenure for which you invest your money and the maturity amount is guaranteed. Moreover, fixed deposit rates schemes are offered by banks, post-offices and financial institutions making them safe and sought after.
While it is true that fixed deposit rates give guaranteed returns, there are some risk factors associated with fixed deposit schemes which you should know about. Here are the risk factors which can be found in fixed deposit schemes –
- The risk of taxation
When it comes to saving tax, fixed deposits are not very effective. Only if you choose to invest in 5 or 10 year fixed deposit schemes can you avail a deduction on your invested amount under the provisions of Section 80C. Even then the deduction is limited to INR 1.5 lakhs. Investing for shorter tenures attracts tax on investments. Moreover, the interest earned on the deposit is completely taxable is you are below 60 years of age. For senior citizens, however, interest earned up to INR 50,000 is tax-free under Section 80 TTB. So, there is a tax risk with fixed deposit investments which you should not ignore.
- The risk of interest
The interest rate promised under the deposit at the time of investment would remain constant over the deposit tenure even if the rates are reduced in future. However, there is a risk of interest at the time of reinvestment. When your fixed deposit matures and if it is rolled over as an investment for another similar tenure, the interest rate allowed would be the rate applicable at the date of the roll-over. This rate might be lower compared to the earlier rate which you received which would be unfavourable.
- The risk of liquidity
Fixed deposits literally mean deposits which are fixed in nature. When you invest in a scheme of fixed deposit, your investment is tied up for the tenure which you choose. During this tenure even if you need funds for an unforeseen contingency, fixed deposits would not come to your rescue. Liquidity is not available in a fixed deposit scheme. If you withdraw the deposit before the stipulated tenure, you would have to pay a penalty on premature withdrawal.
- The risk of inflation
The interest rate is fixed for a fixed deposit scheme. While the fixed rate is risk-free, it does not factor in inflation. Over the course of the deposit, the economy witnesses inflation which reduces the value of money. This reduction in the value of money is not taken into account in a fixed deposit investment. As such, even though you can get risk-free returns, the real value of the returns is low because of inflation.
Thus, a fixed deposit scheme has these small but potent risks which should not be ignored by investors favouring fixed deposit investments. You should also be aware of these risks associated with a fixed deposit scheme before you put your hard-earned money into it so that you know what to expect from the deposit.