Rising FD Interest Rates: Should You Go Long-Term or Short-Term FD?

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Fixed deposits (FD) are one of the safest savings options that guarantee consistent returns regardless of financial market conditions. Although interest rates have fallen in recent years, ongoing inflationary trends point to a significant rise in deposit rates in the near future. It is expected that the rate hike cycle will continue and the repo rate could be raised by another 75 to 100 basis points. This will bring FD deposit rates to over 6% and will soon increase to 7% for longer terms. Once that happens, DFs will once again become an attractive savings option as uncertainty reigns in financial markets. The insurance of fixed returns is attractive.

How do I watch Fixed Deposits now?

Fixed deposits can be a good option if you are a conservative investor and need money in the short to medium term. You can use FDs to park your emergency corpus for future needs in the foreseeable future, say in 2-3 years. Given the uncertainty and volatility in the equity market due to macroeconomic factors and geopolitical tensions, time deposits provide the greatest security for your funds.

Older people generally have the least appetite for risk and place their funds in bank deposits and similar secure securities. Since they are eligible for higher interest rates, between 0.25% and 0.5% more than a general citizen, a fixed deposit is a reliable option for saving and obtaining assured returns. However, fixed deposit yields are still not attractive as real after-tax returns relative to inflation are still negative.

In the current scenario, when rates are rising but real returns are still negative due to inflation and taxation, you need to consider the duration of fixed deposits. You can choose a short-term or long-term fixed deposit. Let’s understand this better:

Interest rates on long-term and short-term FDs

The longer the investment horizon, the higher the interest rate on term deposits. The duration of fixed deposits varies from a minimum of 7 days to 10 years. Short-term fixed deposit has a duration of 7 days to 12 months, while deposits locked for two years or more are considered long-term deposits. However, in terms of interest, investors earn interest as low as 2.5% up to a maximum of 5% on short-term deposits, while long-term fixed deposits can currently earn you up to 6.5%. As compounding comes into play, your performance improves over the long term. This is not the case with short-term FDs. So, in a short-term FD, you will get absolute simple interest, while long-term FDs will allow you to benefit from compounding.

short term DF

Short-term DFs come with a shorter blocking period. Investors who want security in their funds and need cash in 12 months should choose short-term FDs. Since withdrawing funds from DFs prematurely incurs a penalty of 0.5% to 1%, a short term is suitable for such investors. In addition, short-term FDs help investors who have redeemed equity-oriented instruments whose financial goals are close. A short term FD will be one of the best investment avenues to save their funds as there is no risk and the liquidity is high. The rate of return on short maturities may not beat after-tax inflation, but the amount of funds will not see any erosion and investors can use the money for their future needs. It will help if you keep in mind that interest earned on FDs is taxable and the tax rate depends on the investor’s income tax bracket they fall into.

long term FD

Rather cautious investors who do not need funds quickly and those who believe equity-linked investments may not perform well in the medium term, say 2-5 years, may consider opting for long-term FDs. Not only will they get a higher interest rate, compounding will help them get better value at the end of the term. However, keep in mind that fixed deposits may not be a suitable product if the investor’s horizon is longer than five years, as inflation and taxation can significantly overshadow returns. Seniors might consider opting for the maximum term available in fixed deposits.

To finish

An investor should make a wise decision when investing in time deposits, especially when the interest rate cycle is on the rise. Since FD rates are likely to change if RBI raises the repo further, you stand to lose if you lock your corpus into a long-term FD all at once.

You can consider a laddered way to invest in FDs, knowing that the repo rate could see another 75 to 100 basis point hike. On the next rise, long-term FD investors can add another FD to their portfolio while locking it in at a higher interest rate. This will help achieve the best possible returns from FDs.

Based on your financial goals and liquidity needs, you can divide your FD into long-term and short-term FD.

The author is the CEO of BankBazaar.com. The opinions expressed are those of the author.

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