With most of the banks now offering up to 7% or more interest on Fixed Deposits, it is a good time for depositors to lock in some of their funds into high-yield FDs now. Some small finance banks are even offering more than 9% interest on FDs. However, before investing in FDs, you should know some of the disadvantages or limitations of locking funds in a fixed deposit account. This article looks at five such disadvantages.
Low post-tax returns: The biggest disadvantage of investing in Fixed Deposit is the low post-tax returns. For example, if a bank is offering 7% interest on a 5-year FD, the post-tax return for many depositors may work out to be only 5%.
The interest income from fixed deposits is taxed annually. According to Anup Bansal, Chief Business Officer at Scripbox, a bank FD offering a 7% per annum return may give an effective post-tax return of just 4.8% to investors in the highest tax bracket.
Erodes wealth: As the real return from FD gets lower due to taxation, such investment erodes wealth over the long term in view of inflation. For example, in the above case, the 4.8% post-tax return is lower than the average consumer inflation rate, which will eventually erode the wealth of the investor in the long run.
Not the most effective option for tax saving: Many investors tend to invest in 5-year FDs for tax saving under Section 80C, for which the tax deduction limit is Rs 1.5 lakh per year. Also, returns from such investments are subject to tax. Many investors, especially salaried individuals, may not need to invest in FD for Section 80C benefits as they have options like PPF, VPF and NPS for tax-free returns.
Only Rs 5 lakh is guaranteed: If you are investing in a bank FD, only Rs 5 lakh, including the principal and interest, is guaranteed per bank under RBI’s DICGC rules. Compared to FDs, post office schemes like PPF, NSC, KVP and SCSS (for senior citizens) offer guaranteed returns. PPF, NSC and SCSS also give tax benefits.
Not a very good option for long-term wealth creation: While bank FDs are good for saving funds that you can liquidate at any point in time, they are definitely not the best option for long-term wealth creation. Compared to FDs in banks, PPF, VPF and NPS offer tax-free returns. Also, several mutual funds have historically given better long-term returns. But when investing in mutual funds, one needs to be cautious and take advice from certified and experienced personal finance advisors.
Given the rising inflation per year, FDs may not help in covering your future expenses. However, for investors who do not want to risk their capital, FDs may work out to be an ideal option in the current high-interest scenario.
Read next: Disadvantages of Public Provident Fund and Senior Citizen Savings Scheme (SCSS)
(Disclaimer: The above content is for information purposes only. Please consult your financial advisor before investing)
