The ?bird in the hand? theory states that the longer the tenure of parking the money, the higher the return or compensation would be. To choose an optimum time-frame for a term deposit, it is essential to understand the interest rate cycle. With a term deposit, interest rate is fixed for a designated term. From day one, when you open an account, till the end of the term, the investment will earn interest at exactly the same rate.
Term deposits are safe investments because the interest rate that one has signed for guarantees the quantum of return. Returns are not dependent on the share market or on what the RBI decides on short-term rates.
The investor knows his interest rate is guaranteed and this makes a term deposit a safe and secure investment. Deciding the best time to put money in a term deposit depends on several factors, such as how long an investor can keep the money in the account or how quickly he might need to access funds.
For example, the highest interest rates are usually offered on the longest terms where one has invested a large amount and chosen to have returns paid at maturity.
However, this does not mean the best term is the longest one offered, nor should one simply invest all his savings in a 12-month term deposit. Instead, the investor could choose to channel the savings into different tenures, depending on his/her need to utilise the cash in the future, since premature withdrawals have penalties that would ultimately reduce the returns on the principal.
Keep a watchful eye on interest rates. Investors don?t need to know the intricate details of all the market forces that influence the rise and fall of interest rates. However, they should know where the current cash rate stands, where it is predicted to go in the near and long-term future and where on the interest rate cycle are we right now.
Look into past rates to see if rates are rising, falling, or staying the same. As per the current market/interest rate scenario, one should go for fixed deposits (FDs) instead of fixed maturity plans (FMPs) of mutual funds since FD tenures extend for longer time horizons, even beyond five years in certain instances. FMPs, on the other hand, have tenures of 36 months or lower.
Understand interest rates rise and fall in cycles. Interest rates will go up or down and investor will notice the effects of this cyclic movement when he/she become involved in long-term investments. Therefore, if you are looking at investing for a long term, two years or more, avoid doing so when interest rates are at their low point. When interest rates rise again, the investment will be locked in at the lower rate.
Don?t automatically reinvest in the same account at maturity. Some term deposit accounts allow investor to automatically roll over the investment amount into a new term deposit.
It?s convenient, but in the time that the investor?s money has been sitting in the account, interest rates could have risen. Enrolling in the same account earning the same interest rate may not be the best investment.
Don?t hesitate to break that FD if the rates have moved up or your old FD is earning lower. Since the current rates have peaked and would now start moving downwards, any older FDs that have been done at lower interest rates should be liquidated and the proceeds invested in a fresh FD for a longer tenure (if the funds are not required in the near future). It is typically beneficial despite the premature withdrawal penalty that is imposed for early liquidation since the funds would earn a higher return in the future when the market interest rates could be lower.
The writer is CEO and founder of Right Horizons
