When you are looking to open a fixed deposit (FD) account, you should look into both traditional banking institutions as well as non-banking financial companies (NBFCs).
Because, while both of these places are able to hold your money in an FD, there are major differences, especially when it comes to safety, premature withdrawal, and some other aspects.
What is an FD?
A fixed deposit account, also known as a term deposit account or simply an FD, is an account in which you can put money in for a fixed amount of time to accumulate guaranteed interest. Many times, people put funds into one of these accounts as a way to accumulate interest in their savings.
FDs are preferable to other investment options like mutual funds and shares because they require nearly zero monitoring and have a high level of safety.
Opening an FD is a good idea for those who want to save money and earn guaranteed interest. Whether you have a long-term financial goal such as buying a dream car after 5 years, or a short-term objective such as purchasing a streaming service subscription for watching the NFL next month, you can use an FD to get a guaranteed payout at your chosen date.
FDs are generally available for any duration from 7 days to 10 years. You can also create multiple FDs as and when you accumulate some savings.
Banks and Bank FDs: Advantages and Disadvantages
Traditionally, nationalized banks have been the safest option for financial investments in India since they are regulated under the Banking Regulation Act of 1949. Private or cooperative banks have been perceived to be less safe. However, customers today can now get DICGC (Deposit Insurance and Credit Guarantee Corporation) insurance protection of up to INR 5 lakh in these banks as well, putting them on the same safety level as all government-owned banks.
Bank FDs: Advantages
Aside from the safety aspect, banks can offer low or, in some cases, no penalties for premature withdrawal.
You can also get tax benefits that come from using a bank FD. Under the Income Tax Act (ITA) Section 80C, you can claim tax deductions up to Rs.1.5 lakh per year on five-year tax-saver FDs.
Bank FDs: Disadvantages
Overall interest rates in both national and private banks have fallen in recent years, and inflation rates have increased. This means that the interest earned from FDs at banks may not be enough to compete with rising inflation.
If average retail inflation is assumed to be at 6%, bank FDs tend to offer 6 – 7.5% interest. This means that your actual money earned after inflation may be just around 0.5 – 1.5%.
NBFC FDs: Advantages and Disadvantages
There are a lot of differences between FD accounts held at banks versus those at non-banking financial companies, especially since all NBFCs are private institutions that do not have to follow many rules and regulations that traditional banks do.
NBFC FDs: Advantages
Perhaps the best advantage you can find at an NBFC is the higher interest rates. Usually, these types of institutions can offer good returns on FD investments because they have a higher financial risk, meaning their accounts are not insured.
Another benefit to using an NBFC can be online deposit and withdrawal options. Usually, NBFCs offer convenient online depositing as compared to some banks that may not have such a facility. A lot of NBFCs additionally offer renewal rate benefits for those who choose to renew their FD accounts with them.
NBFC FDs: Disadvantages
Putting money into an NBFC is considered risky because these institutions are not covered by the DICGC insurance protection. If an NBFC goes bankrupt, all accounts can lose their money, including the principal amount, immediately. NBFCs also do not offer tax benefits.
Another issue is that most NBFCs charge hefty fees when deposits are withdrawn prematurely. For example, many NBFCs have a 2-3% penalty while banks only charge 0.5-1% for such withdrawals.
While NBFCs do have their disadvantages, many people still find that their high interest rates make up for them. Rating agencies, such as CRISIL and ICRA, offer safety ratings for many NBFCs to help customers decide which institution offers the best safety.
When you are looking to save money in a place that will give you guaranteed interest, an FD account is the preferred choice. While banks offer the safest option for these accounts, NBFCs offer the best interest rates.
A good strategy can be to split your fixed deposit money into bank and NBFC FDs. You can decide the percentage allocation for both categories on the basis of your risk tolerance. For example, young investors in their 30s can choose to invest up to 80% deposit money in NBFC FDs and keep the remaining in bank deposits. Be sure to do your research before deciding.