Every one of us who is earning today surely would want that their earnings multiply at a very pace. Some go it the equity way where there the risk burden is really high and some want to play it really safe by investing their funds in risk free instruments giving them positive returns. One such instrument is your fixed deposit. This is one such instrument where one can find surety of returns on their investment. Therefore many of us keep our savings in fixed deposit accounts which can opened at different branches of the bank proving their account holders with some interest on the amount deposited.
Maturity Period
Fixed deposit (FD) comes with a definite period of maturity though there is no lock in period, so can break his or her FD as and when required. So in times of need one does not have to hover here and there for money when they have FD account. But the main question an investor surely will ask to any financial planner that which is the right time when one should break his or her FD so that their investment are always safe. Today when on one hand the interest rates on almost every kind of loan is rising the simultaneous effect is that rates on different deposit accounts to a going up which tends to make the investors to deposit the money in the respective instruments. Within a time span of a year or so the interest rates have gone up from rate which was around 7% -7.5% to a rate as high as 9%- 9.25%.
Many people who invested their money in FD’s don’t know the when to do so and what will be the effect of such an act on their earning generation. Though there is no fixed time limit which any financial advisor can predict yet there are some minute aspects which an investor should know before breaking up his investment. A fixed deposit which is on the verge of getting matured should not be broken. The investor should try to not take out money until the maturity is reached. The direct effect is that he will have to forego an interest which he could have earned if his fund would have remained intact in the FD till the maturity period of the FD. The rate of interest is taken on an year basis so one should be careful while enough to see that what amount of interest he is foregoing if he breaks up his investment. The best way to explain the above situation is to take a numerical example.
Many people who invested their money in FD’s don’t know the when to do so and what will be the effect of such an act on their earning generation. Though there is no fixed time limit which any financial advisor can predict yet there are some minute aspects which an investor should know before breaking up his investment. A fixed deposit which is on the verge of getting matured should not be broken. The investor should try to not take out money until the maturity is reached. The direct effect is that he will have to forego an interest which he could have earned if his fund would have remained intact in the FD till the maturity period of the FD. The rate of interest is taken on an year basis so one should be careful while enough to see that what amount of interest he is foregoing if he breaks up his investment. The best way to explain the above situation is to take a numerical example.
Examples
Suppose an investor has invested Rs. 200000 in an FD having a maturity period of say 5 years providing the investor with a rate of interest of say 9%. So if the investor now wants to get his money back say after a period of 3 years so he or she has to break the FD. In such a case the rate of interest applicable on his investment will not be 9% but fixed by the bank which may be say 7%. So one will earn just Rs. 42000 as interest compared to an interest of Rs. 90000 which could have been earned if he would have sticked to his investment till the maturity period. This interest earned after 3 years would have been considerably reduced if the bank would have charged penalty for withdrawal of fund prematurely.
So one has to be aware of not only a loss of interest which in the above case is 2%, but also an added loss in the form of penalty, which is charged by the bank which reduces the earning considerably. So before breaking his or her FD one should go on a calculation mode to understand the effects of such premature withdrawal by the investor. The penalty charges of different bank vary but one thing is common in this that such charges not levied on holders of FD if such withdrawal was due to an emergency. But a situation is emergency or not has not been clearly mentioned anywhere. So it depends on the whims of the bank to give waiver and the FD holder has to make necessary arrangement in order to convince the bank about the emergency.
Suppose an investor has invested Rs. 200000 in an FD having a maturity period of say 5 years providing the investor with a rate of interest of say 9%. So if the investor now wants to get his money back say after a period of 3 years so he or she has to break the FD. In such a case the rate of interest applicable on his investment will not be 9% but fixed by the bank which may be say 7%. So one will earn just Rs. 42000 as interest compared to an interest of Rs. 90000 which could have been earned if he would have sticked to his investment till the maturity period. This interest earned after 3 years would have been considerably reduced if the bank would have charged penalty for withdrawal of fund prematurely.
So one has to be aware of not only a loss of interest which in the above case is 2%, but also an added loss in the form of penalty, which is charged by the bank which reduces the earning considerably. So before breaking his or her FD one should go on a calculation mode to understand the effects of such premature withdrawal by the investor. The penalty charges of different bank vary but one thing is common in this that such charges not levied on holders of FD if such withdrawal was due to an emergency. But a situation is emergency or not has not been clearly mentioned anywhere. So it depends on the whims of the bank to give waiver and the FD holder has to make necessary arrangement in order to convince the bank about the emergency.
Ratings
Like banking institutions there are also non-banking financial institutions who accept such deposits. They are also known as company deposits. Company fixed deposits bear higher rate of interest but the creditability of such deposit depends on the ratings given different credit rating agency such AAA, AA etc. the higher the rating given by the rating agency the more is the reliability of return from such company deposit.
Company Deposit vs. Bank Deposit
Generally the rate of interest provided in company deposits is higher compared to interest available from different banks since the risk factors associated with such a deposit is very high. Companies accepts such deposit when there is liquidity crunch in the company so companies dole out higher interest rates deposit which attracts public at large. But investing in such FD should be done before necessary checks. The investment in bank FD’s is a lot safer where the risk is more distributed.
Like banking institutions there are also non-banking financial institutions who accept such deposits. They are also known as company deposits. Company fixed deposits bear higher rate of interest but the creditability of such deposit depends on the ratings given different credit rating agency such AAA, AA etc. the higher the rating given by the rating agency the more is the reliability of return from such company deposit.
Company Deposit vs. Bank Deposit
Generally the rate of interest provided in company deposits is higher compared to interest available from different banks since the risk factors associated with such a deposit is very high. Companies accepts such deposit when there is liquidity crunch in the company so companies dole out higher interest rates deposit which attracts public at large. But investing in such FD should be done before necessary checks. The investment in bank FD’s is a lot safer where the risk is more distributed.
Tax Factor
Apart from the above factor there is also one factor which is to be considered which every one has to consider i.e. the tax factor. Since income on FD in the form of interest is taxable therefore one receives considerably lower amount of interest than what will actually have received. Now the return varies from person to person on the basis of his income. For example if we consider a person whose income is more than Rs. 500000, then he belongs to the highest tax slab where the tax rate applicable is 30% (the effective rate being 30.9%). Now if an investor earns income of Rs. 3000 through interest then the tax on such interest would be at a rate of 30.9% which turns out to be Rs. 927 therefore ultimate amount which he will receive is 2073 (Rs.3000-Rs.927). now one has to understand that as we go down the tax slab i.e. lower income group will have to pay less tax, so their earnings is higher compared to higher income group which is mainly due to the tax rate prevailing in the slab rate. When we convert the above example into percentage form the result will show the same application.
Apart from the above factor there is also one factor which is to be considered which every one has to consider i.e. the tax factor. Since income on FD in the form of interest is taxable therefore one receives considerably lower amount of interest than what will actually have received. Now the return varies from person to person on the basis of his income. For example if we consider a person whose income is more than Rs. 500000, then he belongs to the highest tax slab where the tax rate applicable is 30% (the effective rate being 30.9%). Now if an investor earns income of Rs. 3000 through interest then the tax on such interest would be at a rate of 30.9% which turns out to be Rs. 927 therefore ultimate amount which he will receive is 2073 (Rs.3000-Rs.927). now one has to understand that as we go down the tax slab i.e. lower income group will have to pay less tax, so their earnings is higher compared to higher income group which is mainly due to the tax rate prevailing in the slab rate. When we convert the above example into percentage form the result will show the same application.
Consider Inflation
Another factor which can be considered is the inflation which keeps on fluctuating now days. The effect is that it reduces the value of money for example an investment of Rs. 2000 at 8% fetches for a year fetches Rs. 2160. Now if the rate of inflation is 9% then the value of Rs. 1000 gets decremented by Rs. 90. So the value of investment will not be Rs. 2160 but Rs. 1980 in real sense though the investor would be receiving full amount of Rs. 2160 but the inflationary effect has brought down its value which though not visible works intrinsically.
Therefore one need to well versed with all the above factors in order make his decision regarding breaking of his or her FD which has several effects.
Another factor which can be considered is the inflation which keeps on fluctuating now days. The effect is that it reduces the value of money for example an investment of Rs. 2000 at 8% fetches for a year fetches Rs. 2160. Now if the rate of inflation is 9% then the value of Rs. 1000 gets decremented by Rs. 90. So the value of investment will not be Rs. 2160 but Rs. 1980 in real sense though the investor would be receiving full amount of Rs. 2160 but the inflationary effect has brought down its value which though not visible works intrinsically.
Therefore one need to well versed with all the above factors in order make his decision regarding breaking of his or her FD which has several effects.
