The Advantages & Disadvantages of Fixed Deposits

A good investment strategy is based on choosing investment instruments that are a well-balanced mix of safe and risk. Fixed deposits (FDs) are a popular choice for a safe investment. To invest in a fixed deposit, a sum of money has to be deposited for a specific time period. The period can range from a few weeks to a few years, and the rate of interest is predetermined. Fixed deposits taken from banks are the safest method for this type of investment. There are private money management firms that offer fixed deposit investment options with a higher rate of interest than that given by banks.

Safety

One of the major advantages of fixed deposits as a form of investment is the safety factor. When the deposits are taken from a reputable bank, they provide a very safe investment, because banks are generally regulated by the Federal Reserve, which has supervisory and regulatory authority. Fixed deposits can also be taken from companies that offer this investment option. However, the safety factor is considerably lower, because if the company declares bankruptcy, people stand to lose their money. Companies that offer exceptionally high interest rates should be suspect until completely verified.

Guaranteed Returns

Fixed deposits, apart from being a safe investment instrument, also has the advantage of providing guaranteed returns. The money that is put into fixed deposits earns interest for the investor. The interest is paid every month, every quarter or half-yearly, depending on the bank’s policy. This type of investment is ideally suited for retired persons who need to have an assured source of income each month. The rate of return on the deposits is generally fixed at the time of taking the deposits. However, some banks do offer a floating rate option, and the interest rate is announced every quarter.

Liquidity

Investment in fixed deposits is advantageous in many ways, but it also has a downside. One negative aspect of these deposits is that they do not have high liquidity. Once the money is locked into a deposit with the bank, financial institution or company, the money stays locked in for the duration of the agreed deposit period. People will not find it easy to get their money out in an emergency. Banks and other institutions levy a penalty on deposits that are withdrawn prior to the maturity date.

Lower Rate of Return

The advantage of high safety in fixed deposits is also the basis of one of the major drawbacks of this type of investment. Because of the safety factor, banks in particular offer lower rates of return on fixed deposits. The main reason corporate fixed deposits earn a higher interest rate is that the money is not as safe as it would be in a bank. Most banks are regulated by the Federal Reserve and are not in any great danger of declaring bankruptcy. Investments in companies do not have this security, as they can go bankrupt at any time.