July 15, 2024

Importance of Diversification in Fixed Deposit Investments

Investment for value appreciation or regular income is a crucial financial decision that needs an investor’s informed choice. One of the conventional, safest, and most preferred forms of investment in India is the Fixed Deposit (FD). Fixed deposit, a type of term deposit offered by banks and other financial institutions, promises a higher interest rate compared to an ordinary savings account.

Fixed deposit is an ideal investment opportunity for risk-averse investors looking for guaranteed returns. It offers a predetermined interest rate, ensuring that the initial investment grows steadily over a specified tenure until maturity. However, despite its popular appeal, an informed investor must consider the principle of diversification in fixed deposit investments.

Diversification is a risk management technique that involves mixing a variety of investments within a portfolio. Asset diversification lowers the risk by distributing investments across different types of assets. The essence of diversification is to avoid putting all your eggs in one basket. This principle is crucial in fixed deposit investments to maximize returns and minimize risk.

Interest rates on fixed deposits vary from bank to bank. Diversifying the fixed deposit investments into different banks will not only help in getting the advantage of higher interest rates, but it also reduces the risk associated with investing all funds in a single bank. Furthermore, banks from time to time announce different FD schemes with varying interest rates. Diversification of fixed deposits over these schemes based on a recurring deposit interest calculator can result in a balanced investment portfolio.

A recurring deposit interest calculator calculates the interest that an individual can earn by investing a specific amount of money for a particular period at a predetermined interest rate. For example, if a person invests Rs.1000 in a recurring deposit every month for 2 years at 7% interest per year, the maturity amount at the end of the tenure will be approximately Rs. 26,717. The recurring deposit interest calculator makes calculating these returns relatively easy.

However, investors should note that higher interest rates usually come with longer lock-in periods. Therefore, it’s crucial to diversify fixed deposit investments across different tenures. Such diversification will ensure that the investor has a lump sum amount maturing at regular intervals, providing regular liquidity and taking care of short-term, medium-term, and long-term financial goals.

Additionally, diversification is also important to ensure tax efficiency. In India, under the Income Tax Act, 1961, if the interest income from a fixed deposit in a bank exceeds Rs. 40,000 (Rs. 50,000 for senior citizens) in a financial year, the bank deducts Tax Deducted at Source (TDS). To avoid TDS, one can diversify his fixed deposit in different branches of the same bank or different banks such that interest income from any of these banks doesn’t exceed the specified limit.

To conclude, diversification in fixed deposit investments allows an investor to leverage the benefits of different interest rates, liquidity, regular income, and tax efficiency. The goal of diversification isn’t necessarily to boost performance—it won’t ensure gains or guarantee against losses. However, once an individual decides to invest, diversification can provide the potential for a smoother ride.

Summary:

Fixed deposit is one of the most preferred forms of investment in India that promises a higher interest rate than an ordinary savings account. However, to maximize returns and minimize risk, investors must consider diversification. Diversification incorporates different banks, tenures, and schemes in your investment portfolio that offers various interest rates and allows managing investment risk. Using a recurring deposit interest calculator can help investors better understand the importance of diversification. However, investors should also note the tax implications involved in fixed deposit investments and diversify their investments across different banks or branches to avoid Tax Deducted at Source. However, it is crucial for all investors to consider their financial capabilities and market uncertainties before making any investments.

Disclaimer: 

This article is intended to provide informative content about the importance of diversification in fixed deposit investments, and should not be construed as financial advice. Before making any decision, an investor must gauge all the pros and cons of trading in the Indian financial market.