Learn how fixed deposits work
Fixed deposits are among safe investments available from banks. They typically pay higher interest rates than savings accounts and money market accounts, but there is one drawback: To use a fixed deposit account, you have to lock your money up in the account—although it is possible to get out early, according to www.thebalance.com.
How does a fixed deposit work?
Fixed deposits are a form of time deposit. In return for the higher interest rate, you promise to keep your cash in the bank for a specified amount of time (for example, six months, 18 months, or years).
Higher rates: To reward you for that promise, the bank agrees to pay you more than you would get from a savings account: You get a higher annual percentage yield on the funds you deposit. Why does the bank pay more? Because they know they can use your money for longer-term investments like loans, and you won’t come asking for it next week.
Term options: When you open a fixed deposit, you will choose how long you want to keep your funds locked up. This time period is called the term, and common terms include six, 12, 18, and 60 months, although other terms are available.
Is long-term better? You usually earn more when you go with longer terms. But longer terms are not always the best idea. For starters, you might need your money before the term ends. If you pull your funds out early (which is almost always an option, but in rare cases, banks have denied these requests), you would have to pay an early withdrawal penalty.
That penalty would eat into any interest you earned—and it might even eat into your initial deposit. Because of that penalty, you are better off keeping your money in a savings account if you are going to need it soon.
Maturity dates: At the end of your fixed deposit’s term, it matures and you have to decide what to do next. As you approach the end of the fixed deposit term, your bank will notify you that your fixed deposit is about to mature, and they would give you several options. If you do nothing, in most cases your money will be reinvested into another fixed deposit with the same term as the one that just matured.
For example, if you were in a six month fixed deposit, your bank would automatically put you into another six month fixed deposit.
Note that the interest rate may be higher or lower than the rate you were previously earning—there’s no guarantee that you get to keep the same rate.
If you want to do something besides reinvest into a new fixed deposit, you need to let your bank know before the renewal deadline. You can transfer the funds to your account, or you can switch to a different fixed deposit with a longer or shorter term.
How to start using fixed deposits
To put money into a fixed deposit, contact your bank.
Most banks—especially online banks—explain your options and allow you to make fixed deposit investments online. You can also call customer service, or even speak with a banker in person.
Explain how much you would like to invest, and ask about early withdrawal penalties and alternative fixed deposit products. The bank might have additional fixed deposit options that are a better fit for you, whether they offer higher rates, more flexibility, or other features.
Once you move money into a fixed deposit, you would see a separate account on your statements or online dashboard.
Fixed deposits can be held in almost any type of account including joint accounts, trusts, and custodial accounts.
Strategies for using fixed deposits
Longer-term fixed deposits often seem more attractive than shorter-term fixed deposits because they pay more. However, they are not always the right choice. For example, a five-year fixed deposit locks money up for a long time—it is hard to predict whether or not you would need that money in five years.
What’s more, if you buy a fixed deposits when interest rates are low, you may lock yourself into a low-paying fixed deposits for the next five years—what if interest rates (and therefore fixed deposit rates) rise in the next year or two? You might be better off using shorter-term fixed deposits that renew with higher rates.
If you are interested in using longer-term fixed deposits, evaluate strategies to help you optimise your saving.
The most common strategy fixed deposit investors use is the ladder: Buy several different fixed deposits with different terms so that you would have money available at regular intervals.
Ladders help you avoid locking up all of your money in a low-paying fixed deposit, and they help you avoid cashing out early and paying penalties.
Another way to protect yourself is to use fixed deposits that offer flexibility. They might allow you to:
Get out early without paying any penalty.
“Bump up” your interest rate to a higher rate, assuming rates rise.
As you might expect, fixed deposits with more flexibility offer lower the starting interest rates. Punch