PPF, FD, RD: What Should you Choose?

For secure investments, Public Provident Fund, Fixed Deposit, and Recurring Deposits are great options. You should choose based on what you need.

Have some funds on hand and want to find a good investment venture to make your money work for you? Traditionally, Fixed Deposits have been the go to scheme for short term investments. If you’re looking to lock in money for a longer period, then you can choose Public Provident Fund. Recurring Deposit is another option that’s a great idea to cultivate a systematic savings habit.

With the new financial year about to commence, you must be wondering where to invest. Your choice is guided by weighing the risk vs return and the tax benefits offered. Popular investment options include Fixed Deposit (FD), Recurring Deposit (RD) and Public Provident Fund (PPF).

As a long term investment option, PPF is the best option. The amount you invest is tax deductible, the interest earned on PPF is tax free and the maturity amount is also exempted from tax. Recurring deposit is a type of FD, except that you need to keep making minimum deposits. Also, the interest on RD earns you more than FD.

Fixed Deposits have been a favourite among all class of investors. They offer guaranteed return with minimal risks. Also, if you invest in a 5 year FD, you get a tax benefit as well. PPF, RD and FD are safe investments carrying minimum risk. Post the demonetisation, FD interest rates have fallen. While a PPF gives you 8% return, FDs offer a maximum of 7.5% ( as of March 2017). Further, FD interest is taxable, so your real return will be less.

On the basis of returns, PPF is a good choice. On the other hand, if you want to enjoy liquidity RD/FD scores.

 

Fixed Deposits

  • Bank Fixed Deposits are secure. You get assured returns in the form of interest payments on the deposit
  • The tenures of Fixed Deposits are flexible. You can lock in your money in an FD for a week, or you can save it for 10 years and more
  • Interest rate is fixed at the time of opening the deposit
  • You can either draw out interest payments or reinvest them to increase the returns
  • You can break an FD before full term if there’s an emergency. This involves a penalty and loss of interest
  • You cannot close certain FDs like tax-saver fixed deposit before full term
  • You can take a loan or overdraft against most fixed deposits. This is upto a maximum of 90% of the amount in the account
  • You can invest as little as Rs. 100 in a fixed deposit. There’s no actual limit on the maximum amount you can invest
  • In tax saving Fixed Deposits, the original investment amount is eligible for tax deduction under Section 80C
  • All interest earnings on all fixed deposits are added to your income. They’re taxable according to your tax slab

Pros and Cons of Investing in FD

Pros

  • Steady source of income: When you need a regular source of income, you can depend on FDs to provide the same. Surplus funds can be invested in an FD. This earns you interest, which can be withdrawn at monthly or quarterly rests to fund your expenses. That’s the very reason some retired people park their retirement benefits in FDs.
  • Low risk: FDs fall under the safest instruments. This is because FDs are covered by deposit insurance. Even if you have to break the FD, you just lose some interest. Despite fluctuation in the interest rates, you get the amount that you have been promised.
  • Liquidity: It is very easy to encash your FD. In case, the FD is not due for maturity, you can take a loan against the FD.
  • Convenience: Opening an FD is a simple process. Fill in the application form along with your KYC and your FD is opened. You can fix the tenure ranging between 7 days to 10 years. If you choose a savings linked to your FD, the surplus is automatically transferred to the FD account getting you higher returns.

 

Cons

  • FD interest is taxable
  • In times of inflation, the real return can be negative
  • There is no capital appreciation

The advantages of a Fixed Deposit definitely outweigh the drawbacks. This is evident by the increased number of investors adding Fixed Deposits into their investment portfolios. Diversifying your investment is the best technique to minimise risks and maximise returns.

A popular financial instrument since decades, Fixed Deposits have attracted depositors for their assured returns combined with safety. There are millions of Indians who hold fixed deposits, but do you know how to calculate interest on fixed deposits? The most common method is to use an FD calculator that’s available online. You can also use it to compare the returns from different banks.

With a given set of factors like principal, rate of interest, tenure and compounding frequency, the FD calculator uses the interest and gives you the value that you can get at maturity.

Interest on FDs

Interest on FDs can be opted for monthly, quarterly or half-yearly and yearly intervals. If you’re retired and have parked your retirement benefits in an FD, then monthly credits from interests can give you a steady income flow. FD interest calculator can be used to calculate the amount of interest that is credited to your savings account.

What you get on your FDs is interest. As a trade practice, banks resort to quarterly compounding. So, the interest is calculated every 3 months and the interest added to the principal deposit amount. The next quarter interest is calculated on the principal plus the interest of the first quarter.

The RBI has decided that banks can compound even at shorter intervals at less than a month. The higher the compounding, higher would be your returns from the Fixed deposit.

Post demonetisation, banks have slashed FD interest rates as a result of which investment in fixed deposits have reduced.

Calculating The Maturity Value

When you do the Fixed deposit maturity calculation, you need to factor the principal amount, annual nominal interest rate, tenure of deposit and frequency of compounding. FD maturity calculator can be accessed online to check what is the amount your fixed deposit investment will yield after a particular period of time.

So, the amount at maturity will be the sum of the initial deposit plus the compounded interest accumulated during the deposit tenure. If TDS has to be deducted, then the maturity value will be reduced to the extent of tax deducted at source.

Working of Fixed Deposit Calculator

With the help of a FD calculator, you can know the interest you will earn and the maturity value. Almost all banks offer the facility of an online FD calculator. You need to enter details. These include the principal, rate of interest, tenure and compounding frequency.

Factors Impacting Returns on FD

  • Taxation

FD interest rates were high until about 3 -4 years ago. On average, a 5 year FD earned you 10% interest. However, this rate is the pre-tax return. In actual terms, the rate of return is much lower than 10% when you consider the interest after tax. That’s because FD interest is taxable. Each investor pays tax based on the slab they fall in.

Interest earned on FD is taxable. How much tax you pay on interest depends on the income tax slab in which you fall. If you fall in the 20% tax bracket, you pay 20% tax on the interest income.

FD interest is also liable to TDS if the amount paid by a bank towards interest exceeds Rs.10000 in a financial year. In this case, TDS is deducted at 10%. By splitting your FDs, you can avoid TDS. If you have no taxable income in any financial year, you can submit Form 15G/15H to ensure that banks don’t automatically deduct TDS.

The next time you need to invest in a FD and are wondering which bank to choose, go online and use an FD calculator. Calculate the returns based on the interest rates offered by different banks and see what works for you. There’s no one right answer for everyone, since everyone has different financial needs and conveniences.

  • Inflation

Inflation is an unavoidable factor. When inflation rises, the value of the rupee decreases. In long term FDs, when you factor the inflation, the returns that you get can be on a negative scale as well. That effectively means that you’re not just losing money, you’re also losing the initial principle amount that you locked in.

To cite an example, suppose you’ve invested Rs. 10,000 in a long term FD at 7%. If the prevailing inflation rate is 6.5% and your tax slab in 30%, your first year return would be Rs. 700. However, by the 8th year, your return would be a very meagre, Rs. 237, after you adjust for tax and inflation. So, in effect, the real return you’d get would be around 2.37%, even with annual compounding at work.

At face value, it looks as if long term FDs offer a higher return. But in reality, the real return is a lot less. If you have to compare the returns on a long term FD with any other investment option, you can get a clear picture only when you calculate it after the tax returns, and adding inflation into the factor. That’s why it’s recommended that you choose a short term FD instead of a long term deposit.

If a chunk of your investment is in a long term FD, and if you have to break it for some reason, then you’ll lose interest and pay a penalty. That effectively brings down the ROI. Instead of punishing yourself with this kind of penalty, you can have short term FDs for a specific duration to meet any cash expenditures that you may need. This avoids the penalty and the loss of interest that you may otherwise be charged.

A long term bank FD is a safe option. But it can be a cash sink, when you consider inflation rates and taxes. After demonetisation, FD rates have fallen. The industry estimates an increase in inflation rates. In this case, the best way to earn positive returns is through a short term FD.

Public Provident Fund

  • The PPF scheme is aimed at all types of investors. You can invest as little as Rs. 500 or a maximum of Rs. 1.5 lakhs in a year
  • Interest rates on PPF is currently 8%. This makes it a better option than fixed deposits in the current scenario
  • Lock in period for PPF is 15 years
  • Premature closure of PPF is allowed after five years. That’s if you can furnish proof of medical or other emergency need
  • Partial withdrawals are allowed penalty-free after seven years
  • You can make monthly deposits into your PPF account, but the total deposit for the year cannot exceed Rs. 1.5 lakhs
  • The deposit amount in PPF is eligible for tax deduction under Section 80C
  • The maturity amount is tax-free

Recurring Deposit

  • You can open an RD for as little as Rs.10
  • You have to make a deposit for the same amount each month for the duration of the scheme
  • RD rates are comparable to fixed deposit rates
  • Premature closure of RD account incurs penalties
  • Interest on RD is taxable based on your tax slab

Which is Best?

  • If you want to invest a lump sum, then a fixed deposit or PPF is the better option
  • Most fixed deposits are made for upto five years. PPF schemes are locked for a 15 years period
  • Interest paid on Fixed Deposits and Recurring Deposits are taxable
  • PPF is completely tax-free, the principal amount and the interest earned are both tax exempt
  • Fixed deposits are more liquid than PPF. This means that you can close them anytime. But there is a penalty
  • You can take loans against PPF, RD, and FD
  • Recurring deposits aren’t for huge sums. They’re mainly created to cultivate a savings habit

You don’t have to choose any one of them. You can split your money across all three options. That gives you a lot more flexibility in your investment.

Author: Eddy

Eddy is the editorial columnist in Business Fundas, and oversees partner relationships. He posts articles by others on various topics related to strategy, marketing, supply chain, technology management, social media, e-business, finance, economics and operations management. The articles posted are copyrighted under a Creative Commons unported license 4.0. To contact him, please direct your emails to editor.webposts@gmail.com