Fixed deposits are considered safe and secure, and offer guaranteed returns. In this article, we will discuss two key points regarding FDs: when to invest in FDs and how safe they are.
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When to invest in fixed deposits?
The formula to determine when to invest in fixed deposits is straightforward. You should invest in FDs when the interest rates you receive are higher than the target rate of inflation. The target range of inflation is decided by the Monetary Policy Committee (MPC), which is one of the arms of the Reserve Bank of India (RBI).
The tolerance limit of inflation in the Indian economy is 4% to 6%. This means that if the price of goods and services increases by 4% to 6% every year, it is acceptable to the economy. For instance, if an apple used to cost ₹100 and its price increased to ₹104 to ₹106, it is considered acceptable.
Return offered by Bank on Fixed Deposits > Target rage of Inflation
If you invest in fixed deposits in HDFC Bank or good corporate accounts, you can expect to earn around 7% to 7.5% interest. As per the formula, you should invest in FDs as your return on investment is higher than the target range of inflation.
Inflation is currently high in the Indian economy and across the world, but it is expected to come down in the future. If you invest in a three-year FD and the inflation rate drops to 6% in two years, you will earn a profit of 1.5% return.
How safe are fixed deposits?
While fixed deposits are considered safe and secure, it is essential to choose the right bank or institution to invest in. Many small regional cooperative banks offer higher interest rates than larger banks, but they are not always safe.
The Yes Bank crisis in 2020 is an example of how depositors faced mass panic when the bank was unable to return their deposits immediately. A moratorium period was introduced, which prevented depositors from withdrawing their money until liquidity was infused into the bank. While depositors eventually received their money, it caused a lot of trouble and negative news for the bank.
The Punjab and Maharashtra Cooperative Bank (PMC Bank) faced a similar crisis, but depositors have still not received their money as a whole. Retail depositors are required to take a haircut of 30% to 43% as they will not receive interest for the first five years and ten months. This means that if you had deposited ₹100 in PMC Bank and earned an interest of ₹10, you would only be able to recover around ₹90.
The reason why depositors of Yes Bank received their money while PMC Bank depositors did not is because Yes Bank is a large bank, and if it had completely collapsed, many people would have lost their money. Small cooperative banks that are 5% the size of larger banks do not receive the same attention from the government or regulators.
Open an Online FD account with HDFC Bank
Conclusion
Fixed deposits are a safe and secure investment option, but it is essential to invest in the right institution. Always check the interest rates offered by the bank and ensure that it is higher than the target rate of inflation. It is better to invest in a larger bank that is regulated by the government than a small cooperative bank that offers higher returns.
Also read: Public Provident Funds
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