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A fixed deposit (FD) is considered as one of the top investment avenues for a safer investment. It is an excellent option for newbie investors or retired individuals that have capital protection as their primary goal. The backing for this notion at large is because of the safe, liquid and assured fixed income that this investment offers to its investors.
But are fixed deposits risk-free? The term ‘risk’ is associated with returns vis a vis its capital protection. Having your capital intact while receiving a steady rate of return is not necessarily risk-free. Let us understand the various challenges that you might face when you apply for a fixed deposit –
Liquidity Risk
Fixed deposit brings an element of certainty with regards to its maturity value. But during its stipulated duration, there is not much liquidity. If for some reason you require the money, there can be a penalty for premature withdrawals too. A tax saver FD, on the other hand, has a lock-in period of five years and cannot be liquidated earlier. Some financial institutions do not permit online liquidation of such fixed deposits and one may need to visit a branch for the required formalities.
Tax Risk
Section 80 TTB of the Income Tax Act exempts the interest on up to Rs 50,000 from tax for senior citizens who are above the age of 60 years. For all others, your FD interest is taxable as per the tax laws. Your interest is combined with your other sources of income and if you fall in the 30% tax bracket, a 7% Interest rate may effectively provide a return of only 4.9%. These returns are further diminished with the inflation levels prevailing in the country.
Default Risk
The default by a financial institution is a rare case, although there lies a certain risk to each time you invest in fixed deposit. In case of a default, the Deposit Insurance & Credit Guarantee Corporation offers a cover of Rs 5,00,000 (earlier Rs 1,00,000) to protect you from financial loss. This is applicable only in case of fixed deposits with banking institutions.
Concentration risk
Diversification of your portfolio is the best way to hedge the risk and at the same time maximizing your returns on investment. FD interest rates do not offer the maximum returns that otherwise, you could earn from other investment avenues. But, if combined with other investments, it definitely will help in spreading the risk and protecting your capital.
These are some of the challenges when investing in fixed deposits. Make sure you keep in mind the above limitations and invest in fixed deposit.
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