Everything You Need to Know About: What Is an FD and Its Working

Save & Invest

At some point in your life, your parents must have told you to invest in fixed deposits. But have you ever wondered why? What is so special about them? In this article, you will learn about fixed deposits, the type of investment they are, their pros and cons, and whether investing in FD is the right thing for you.

What is a fixed deposit?

A fixed deposit is a type of account you open with a bank or NBFC (non-banking financial company) that offers a fixed interest rate for setting aside a certain sum of money for a particular term. An FD is sometimes called a CD (certificate of deposit) or TD (term deposit). 

An FD is essentially an investment account where you, as an investor, have to invest money for a set period, and in exchange, the institution will offer you a fixed interest rate depending on the amount you deposit and the time you choose to keep the money invested. These two conditions make up a fixed deposit. 

How does a fixed deposit work?

When you go to a financial or non-financial institution that offers fixed deposit accounts, you will be given certain pre-determined options in terms of how much money you can invest, how long you need to hold that money in the account, and how much interest you will get on it. 

For example, let’s consider an FD that offers 7% interest per year with a set holding period of 700 days. Let’s say you invest Rs. 1 lakh in it. Then, after the 700-day maturity period, you would have roughly Rs. 1.14 lakh.

Note that a fixed deposit is generally a one-time payment that you make at the beginning of the term. You may or may not have the option to invest more later on, depending on the type of FD. Some institutions offer systematic deposit plans for their FDs. You should also not withdraw the money before maturity, as you will not get the promised FD interest rate.

So before investing in FD, ensure you have enough liquid cash for your other needs. This way, once you start an FD, you only have to withdraw it after its maturity period unless there is an absolute emergency and you need the funds back.

Pros & Cons of a Fixed Deposit

It is a low-risk form of investment as compared to many other types of investments available in the market. Since a fixed deposit is a type of investment that is less risky than other forms of investment, the returns are also lower compared to investments in something like equity stocks. 
It has a much higher rate of interest when compared to a savings or current account with a bank.You may lose the interest you accumulate partly or entirely over time if you decide to withdraw the money from the FD account prematurely. The amount you lose will depend on the cycle during which you withdraw the money.
Even though you should not withdraw the money you invested in FD before its maturity period, you can easily withdraw the money at any time you need it.  

Features of a Fixed Deposit

Before you start investing in FD, here are some things you should know about it:

  1. A secure form of investment: A fixed deposit is a secure form of investment, as the FD interest rates set at the beginning of the tenure are exactly the returns you will get, even if the rates are lowered later on. This makes it a much safer bet to invest money in than other market-led instruments, such as stocks, which are much more volatile.  
  2. Compounding interest: People consider many factors before investing their money in an FD. One of them is known as the frequency of compounding. Regular FDs accumulate the fixed interest rate only once a year. But some FDs accumulate interest twice a year or more. This means you earn interest not just on your principal amount but also on your interest amount.   
  3. Flexible term periods: A great thing about investing in FD is that you can decide how long you want to keep your money in an FD. Remember that the longer you hold your money in a fixed deposit, the more returns you will get due to the compounding effects of the interest rate.  
  4. Fixed interest rates: – Most types of investments that promise high returns are often volatile, and the rate of interest is subject to change. But unlike other forms of investment that may or may not give you the predicted or promised returns, an FD will always give you a fixed return as promised at the beginning of the tenure of your fixed deposit
  5. Get a loan against your FD: Another benefit of having an FD is that you can take out a loan against it if you need money urgently. Rather than breaking the tenure and withdrawing money from the fixed deposit account, you can simply use your FD as collateral for a loan. 

Should You Be Investing in FD?

You should invest in a fixed deposit if you want to safeguard your money for the future and earn assured returns on it. But to grow your money faster, look at investing in other avenues, such as the stock market. Once you have earned profits through other investment forms, choosing a fixed deposit to safeguard your money is a wise choice.

NOTE: The information above is not financial advice, and you should always do your research and consult an expert before investing. 

Piramal Finance is one of India’s leading financial services companies. To learn more about how we can help you make better financial choices, check out our products and services on our website.