Know All About a Fixed Deposit, its interest rates & How it Works?

Every one of us, at some juncture, has to make some sort of investing or saving decision. An advice we Indians generally receive is to invest in fixed deposits also known as FD, full form – fixed deposit. FDs are safe investment options that give investors a constant, stable income stream in the form of interest payments over time. Nowadays, the growing awareness of investing and saving among people has led to the increasing participation of retail investors in the financial market. Investing and saving-related terms like returns, stock market, bonds, etc., have become common parlance.

However, before the wide prevalence of investing or trading in equities and the market reforms of 1991, bonds, cryptocurrencies, foreign exchange, etc., FDs accounted for most of the Indian household savings, both rural and urban. Fixed deposits or FDs have been and will continue to be a crucial element of the Indian economy. In this article, we will try to understand what a fixed deposit is, its features, and how it functions.

What is a Fixed Deposit?

Also known as FD, full form fixed deposit, a fixed deposit is an investment tool wherein an investor deposits a certain sum of money with a bank or an NBFC (Non-banking financial institution) to receive a stream of future cash flows. These streams of future cash flows can also be interpreted as investment returns. The quantum of return on investment depends upon the interest rate offered by the banks and NBFCs to the depositor/investor.

Features of a fixed deposit:

Fixed deposits have the following characteristics:

  • Consistent, stable return: Fixed deposits provide a stream of fixed, stable cash flows to investors, depending upon the interest rate. For instance, a fixed deposit of Rs. 1,00,000 for an interest rate of 7.5% for 10 years would translate to an annual return or cash inflow of Rs. 10,000 for 10 years.
  • Guaranteed Returns: The returns of fixed deposits are assured and can be thought of as a pledge by the banks and NBFCs. Unlike other investment tools like equities, bonds, foreign exchange, etc., the return on fixed deposits is unaffected by any market volatility. This means that if your fixed deposits have an interest rate of 7.5% per annum, you will get interest payments of 7.5% p.a. even if the interest rates on the market have dropped or risen significantly. 
  • Interest Rate: The interest rates on fixed deposits can vary. Different banks and NBFCs provide varying interest rates on fixed deposits depending upon the tenure of the fixed deposit. Fixed deposits with long term typically have higher interest rates than those with short tenure.
  • Flexible tenure: Fixed deposits are offered in wide varieties and are accessible with terms ranging from a week, 7 days, to 10 years. The length of the fixed deposit tenure affects the interest rate on fixed deposits, with higher deposit tenure translating to higher interest rates.
  • Senior citizens friendly: Senior citizens get special fixed deposit privileges like special interest rates, typically higher than the general interest rates. Additionally, they can avail of tax deductions under Section 80C of the Income Tax, IT Act. They are offered different options on the frequency of interest payment like monthly, quarterly, biannually or yearly. 

How does a fixed deposit work?

Fixed deposits provide investors with interest payments on regular intervals as investment returns. But, you might be asking yourself how exactly the banks and NBFCs can provide these interest payments. Banks and NBFCs, like other business establishments, are profit-oriented. They use the money deposited by the FDs investors to offer loans to businesses and individuals seeking loans at an interest rate higher than the one they are providing at your FD. So, if a bank offers your rate of interest of fixed deposit at 7.5% pa, they would charge higher than 7.5% on loans and credits. The variation between these interest rates is the banks’ or NBFCs’ income, also known as Net Interest Income (NII)  and how a fixed deposit works.

Fixed deposits are a safe, reliable investment vehicle that investors should include in their portfolio. This would not only generate interest returns but also diversify your investment portfolio. This statement is especially true in an economic downturn where risky financial assets like equities tend to generate a lower return on investment.