Major Investment Mistakes Young FD Investors Should Avoi
Fixed Deposits have incessantly been prevalent as the basic investment option for beginners in India. It attracts investors from all age groups but mainly youngsters or first-time investors. As a young investor, one should be aware of before initiating any transaction. What empowers this investment is its evident risk-free nature, assured returns, and stability. Since Fixed Deposits are a developed yet evolving arena of the investment sector, it varies across its own spectrum. Although the basic nature of a Fixed Deposit is the same, all FD‘s are not the same.
On a broad basis, we can divide Fixed Deposits into two categories: company deposit and bank deposit. It is important to understand the difference between the two for starters.
Banks invite deposits to raise their capital for banking activities. Precisely, banks use deposits from investors to raise capital to lend at a higher rate to borrowers. The difference between deposit and lending rate acts as the income for the bank.
On the other hand, companies hold fixed deposits to raise capital for business purposes. Consequently, the return rate of interest is higher than fixed deposits done with a bank. Therefore it is often seen that people invest in company FDs over bank FDs. However, a high-interest rate should not be a reason to determine an analysis of the given option.
Let us go a further mile and compare its positives and negatives.
Company FDs provide a flexible tenor. The range for such deposits can be selected from 12-60 months. Additionally, the interest rate payment is flexible, as well. Someone may opt for a monthly interest payout while the other can opt to receive interest yearly or at maturity. This level of flexibility is exclusive to corporates and cannot be found in banks.
As mentioned above, the company FDs yearn higher interests. The interest rate is much higher than that of banks. The current interest rates for FDs in banks is between 3.50 and 7% while interest rates generally offer 7.85% to new customers. These deposits give out even higher interest (7.95%) to existing customers and (8.1%) to senior citizens.
High-interest rates can be suspicious; thus, special safety measures are taken. Credit rating agencies crucially evaluate company deposits. These agencies review the safety and stability of corporate FDs. Basically, they inspect the financial data of the company to conclude its financial health. These ratings are updated periodically.
If a company has a high credit score, chances are it will pay you interest on time. Subsequently, the deposited principal remains safe. CRISIL rated company deposit facility as FAAA, which indicates “highest safety” in terms of timely payment of interest and amount. Nevertheless, it is advised to check the credit rating of a company before investing in its fixed deposit.
Along with high rates of interest, companies may provide additional incentives to their customers. This acts as a reinforcement to renew their deposits again. NBFCs offer 0.10% added interest on the renewal of deposits, for instance.
Not suitable for emergency
Any medical, financial, or personal emergency can compel you to close or withdraw your FD before the maturity period. Here, corporate deposits charge higher penalties than banks. Other than that, due to pre-closure, some companies may repay only the principal amount and not the interest amount.
Loss of capital
At times a company with low credit score can allure investors due to their high rates of interest. This is misleading and puts your credit at risk. Opening an FD with such a company can be risky as the company may not be able to pay the interest on time.
Lower returns than equity
As compared to equity or equity-linked investments, corporate deposit returns can be lower. But if we look at it from this perspective, then equity investment can be a riskier proposition.
Major mistakes that young investors must avoid
Young investors, who are new to the market, are told to invest in FDs as it is quoted as the safest, simplest, and most stable amongst other options. However, it is not as foolproof as we think it to be. Commonly, young investors might commit mistakes while beginning investment in FDs.
Let us discuss some of the frequent mistakes committed by youngsters while making an FD:
If you plan to close your FD account before the maturity period, it will result in a penalty. Even if you can suffer the loss on your interest, you can still take a loan against it at a lower rate of interest. This can help in the case of an emergency. Anyone can take high loans against their Fixed Deposit wherein it acts as collateral.
Excluding FD Interest while filing tax returns
If you think you can dodge income tax by putting it into an FD, you are absolutely wrong. The interest earned on FDs is not at all tax-free. Any interest amount above Rs. 10,000 is indeed taxable.
Dependence upon FD to counter inflation
Whilst a scenario of inflation, FDs can be useful but only up to a certain level. It is hereby advised to diversify your portfolio to have back up options like mutual funds and trade markets. Such a mixture of risk-free deposits along with high-paying investments, on the other hand, can be much more helpful.
Doubting FD Returns
If there is a level of uncertainty in the expected returns from an FD, you must keep it. However, clearing this doubt by thorough research is even more important. Before investing, follow the three C’s, i.e., Compare-Clarify-Choose the best deposit policy according to your return requirements. Go for the option that gives you maximum stability and high returns.
It is advised to only invest a part of your savings into FDs as taking out FDs in case of emergency situations is a tough task. Forgetting than an FD is a FIXED amount that is the biggest mistake that can be committed during such an investment process.
Fixed Deposits can give you high returns even if you start small. This can only be succeeded without any complication if you do thorough research, read the terms and conditions, be aware, and follow the 3 C’S of Compare-Clarify-Choose. An investment done early gives high returns if you give it time. Therefore, take your time to think and invest wisely.
For investing in FDs in companies, various points need to be understood. Firstly, one should differentiate between bank and company deposits. Banks use the deposit to earn their income. Companies use it as an investment and pay a higher return on FDs than banks.
Along with higher returns, there are other advantages as well:
Credit Rating Agencies rate companies after assessing their financial condition. This provides a fool-proof way of knowing how financially reliable the company is.
- Whether in terms of maturity period or interest payment, that is a monthly payment, or yearly, company FDs are very flexible. If one’s salary is not enough, anyone can withdraw it monthly, as well.
- The interest rate is increased for people who renew their FDs.
However, there are some drawbacks:
- If FD is closed before maturity, companies charge more than banks. Also, sometimes, they return only the principal amount. So, one should avoid doing that, and if there is an emergency forcing you to close your account before maturity, this will be a loss.
- Equities are riskier than company FDs, and they give a higher return.
Along with these, one should be careful not to invest their entire savings in FDs. Another mistake made by investors is that they forget to include FDs income in their tax, which may cause problems. If one is competent enough to know the right facts and make the correct decisions, FDs are a good investment.