Fixed deposits are debt instruments that promise a regular stream of income. Nothing can match fixed deposits when it comes to safety, security and assured returns. Though the returns are modest in comparison to other investments, fixed deposits continue to be the epitome of low-risk instruments.

However, due to its familiarity and ubiquitous presence, investors often overlook even the most obvious and simple facts that have much bearing on their returns. Failure to take these essential and simple facts into account can heavily erode our returns. Here are some simple tips that will not only assist you in understanding these simple facts but also will help you in making the right choice.

Fixed Deposits vs Low Risk

Most investors go with the assumption that all FDs carry equal risk and offer similar returns but the FD market is quiet variegated. Fixed deposits are not only issued by banks, which most investors prefer, but also by big corporate houses, NBFCs and cooperative societies. Corporate deposits are generally called company deposits, and they offer higher interest rates when compared to bank deposits. This is due to the fact that company deposits carry high rate of risk and return, and unlike bank deposits, corporate FDs are unsecured and not backed by deposit insurance. Fixed deposits up to Rs 1 lakh maintained with banks are backed by deposit insurance. Besides, company deposits are rated based on their risk profile by the rating agencies. A fall in the ratings would cost us dear.

Investors can either opt for company deposits or bank deposits based on their risk appetite but due diligence has to be exercised in case of corporate FDs because corporate name, business prospectus and ratings alone do not suffice, the financial health of the company is always determined by its financial reports like the profit and loss account. Although corporate FDs offer higher interest rates, companies with high interest rates, low investment grades and poor dividend records should not be preferred. Partnership firms should be avoided at any cost.

Additionally, investors should know whether the interest is calculated annually and paid quarterly or monthly under simple interest method or compounded quarterly under compound interest method.

Another important point to note is that public sector banks offer high interest rates when compared to a private bank, and hence fixed deposits maintained with public sector banks not only offer high returns but also are more secure and safe. Besides, senior citizens enjoy higher rates of interest when compared to other investors.

Tax Implications

All investors have to understand that interest returns from fixed deposits are tax adjusted and not tax free.

The interest income from fixed deposits is added under the head ?income from other sources? while computing the total taxable income and the tax rate under respective tax slab is applied to the total taxable income.

Apart from this, TDS (Tax deducted at source) is applied by the banks for interest incomes above Rs 10,000. TDS at the rate of 10 per cent is deducted from interest income above Rs 10,000 if PAN details are disclosed and a failure to disclose PAN details would attract TDS at 20 per cent.

Likewise, provided that certain conditions are met, self declaration forms like Form 15G (non-senior citizens) and Form 15H (senior citizens) have to be submitted to the respective banker for claiming TDS exemption or deduction.

Additionally, I-T exemption under 80C can be availed for deposits up to Rs 1 lakh with five years maturity period.

Any laxity in understanding the above tax implications will lead to heavy erosion in the value of the investments. Tax deducted at source can also be avoided if a lump sum amount is broken into separate parts and deposited in different banks. However, the total income earned from interest has to be disclosed for computing Income Tax.

The Question of Liquidity

Fixed deposits are not as liquid as savings or demand deposits and banks impose penalties on premature withdrawals. To mitigate the costs associated with low liquidity, many investors deploy a strategy called ?Laddering of FDs.? Under this strategy, instead of investing a lump sum amount (say, Rs 3 lakh) in a single FD with a longer maturity period (3 years), the lump sum amount is broken into 3 tranches of Rs 1 lakh each and invested with varying maturity periods, say, one tranche for one year, the other one for two years, and the third one for three years.

This strategy not only promises a regular stream of income but also safeguards the investments from interest rate fluctuations because we have the option of reinvesting the deposits on maturity. We need not opt for premature withdrawals in case of a spike in interest rates. The other strategy for small investors is to go for fixed deposits with shorter maturities. Given this scenario, the point of caution is that fixed deposits are not foolproof either against inflation or vagaries of interest rates.

Diversify Your Deposits

Keep a diversified portfolio of both corporate and bank deposits, or one could have his deposits diversified in different banks. This could secure the investments both against market risk and credit risk.

The above points make clear that it is only these simple facts that matter the most in making the right choice regarding fixed deposits.

The author is CEO, BankBazaar.com