Time to take a serious look at fixed deposits

It may sound stupid for aggressive investors to talk about fixed deposits, when diversified equity schemes on average have given about 40% returns in the past one year. But fixed deposits are important and there are strong reasons why they must be on? investors’ radar at this moment. Let us understand this in greater detail:?

U-Turn in Rates

The US Federal Reserve has cut policy rates by 50 basis points. Market participants were expecting a 25 basis points cut. In CY2022, the US Federal Reserve raised policy rates by 500 basis points to curb inflation. As inflation cools down and the economy slows down, the policy focus changes to stimulate economic growth. A rate cut in the US along with Europe and some other developed nations including China can pressurise central bankers in the rest of the world to consider rate cuts. The Reserve Bank of India won’t be an exception. Experts may argue on the quantum and timing of cut in repo rate. For time being, let’s expect a minimum 50 basis points cut in repo rate, before March 2025.

Fixed deposits and debt funds

When interest rates go down, investors prefer to buy long duration bonds or units of long duration debt funds. This time however, the long-term bond yields have already adjusted. So, investors may want to allocate some money to medium and short duration bond funds, with a view to benefit from falling rates. When interest rates fall, the bond yields adjust downward and prices of bonds go up. This rewards investors with an opportunity to book capital gains.

Fixed deposits at this juncture are also attractive. If the policy rates are cut, then interest rates in the economy will fall along with the rates on fixed deposits. Hence, investors can consider locking in current interest rates by investing in long-term fixed deposits.

Many investors may wonder why they should be even thinking of investing in fixed deposits, when the stock markets are doing good. The biggest advantage a fixed deposit offers is assured returns. When a financial goal is due in less than a couple of years, there is no point keeping the money accumulated for that goal in risky assets such as stocks. If the stock markets tank and take time to recover, then an investor may not have adequate funds to pay for her financial goal. Funds accumulated in good quality fixed deposits ensure peace of mind for an investor

Also, current interest rates on fixed deposits are attractive. If we consider the expected rate of inflation at 5%, then the current nominal rate of around 7% on many one-three years fixed deposits offer a positive real return of approximately 2%. Real return is computed by deducting the rate of inflation from nominal rate of interest. If inflation falls, then it makes sense to lock in the interest rates by investing in three or five years fixed deposits.

While investing in fixed deposits for the long-term do check the issuer’s credit rating. Opt for AA or AAA rated fixed deposits. Company fixed deposits reward investors with better interest rates than bank fixed deposits. However, do not chase returns on fixed deposits. High interest rates may be an indication of high credit risk. Hence be prudent and stick to good names such as Shriram Finance and Bajaj Finance.

Also, figure out the cash flow requirements before signing up for fixed deposits. Ensure that a fixed deposit tenure matches with your investment timeframe. Premature withdrawal requires some running around in company fixed deposits and it attracts penal provisions on interest.

Investments in fixed deposits should be guided by the asset allocation needs of an investor, and not solely by what is attractive or fashionable in the financial markets. For long-term investors focused on goals such as retirement which are due more than five years away, investments in diversified equity funds using systematic investment plans (SIP) and systematic transfer plan (STP) still make sense.

For those seeking shorter-term investments, fixed deposits make sense. Therefore, it is the time to make use of these traditional products to optimise returns on your overall portfolio.

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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