Fixed Deposits (FDs) are investment instruments offered by banks where you deposit a lump sum amount for a fixed period at an agreed interest rate. Upon maturity, you receive your principal amount along with the accumulated interest. While FDs are considered highly secure due to their predictable returns and low risk, it is still important to adopt a diversification strategy.
Diversification is the process of spreading your investments across various assets to reduce risk. For fixed deposits, this means not putting all your money into one FD. But why is this necessary? Keep reading to find out.
Understanding why it is important to diversify your FD portfolio
Diversifying your FD portfolio is a smart financial move with several benefits.
- Interest rate variability: Different banks offer varying interest rates on FDs. By diversifying your FD portfolio, you can take advantage of the best available rates. Moreover, having investments across different banks also ensures that your entire capital doesn’t get affected by the performance or terms of a single bank deposit.
- Maturity period flexibility: FDs come with a range of maturity options, from a few months to several years. Diversification allows you to stagger the maturity periods of your investments. This strategy, often referred to as a “ladder,” boosts liquidity and reduces the need to break a high-amount fixed deposit prematurely in case of emergencies, which might incur penalties or result in lower interest.
- Adaptability to interest rate changes: Interest rates fluctuate based on economic conditions. Diversifying your fixed deposits offers you the chance to capitalise on fluctuating interest rates. When your one fixed deposit account matures, and rates are up, you can reinvest the proceeds at higher rates and optimise your earnings.
- Goal-based saving: Different goals require varied timeframes and amounts. By diversifying your FD portfolio, you can align specific FDs with particular goals. For example, you can have an online fixed deposit for emergency funds, another for a short-term goal like a holiday, and a long-term FD for major expenses like education or a house.
- Easy tax planning: Interest income from bank deposits is taxable as per your applicable income tax slab. When you strategically allocate your investments across multiple FDs, possibly with different banks, it is possible to manage your annual tax obligations more efficiently.
Tips to diversify your FD portfolio
Here are some useful tips for diversifying your fixed deposit portfolio:
- Seek out banks offering top interest rates: Book an INDIE Fixed Deposit and enjoy industry-leading interest rates of up to 7.75% p.a. Choose from different types of FD plans, from auto-sweep to tax-saving FDs, all available through a 100% digital process. Launched by IndusInd Bank, use INDIE as your go-to online FD app to track your investments in real time, enjoy multiple payout options, and customise savings your way.
- Mix tenures wisely: Construct your FD ladder carefully. Include short-term, medium-term, and long-term deposits in a way that you have funds maturing at regular intervals. This approach provides liquidity and allows you to reinvest at potentially higher rates in the future.
- Open FD online with multiple banks: By opening FDs across different banks, you do more than just mitigate risks and optimise returns. This method also ensures that your investments remain within the insurance limits set by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which is up to ₹5 lakh for each bank. For example, if you have FDs in two different banks, you will have a total insurance cover of ₹10 lakh. This includes both the principal amount plus interest.
- Have both cumulative and non-cumulative FDs: This approach serves dual purposes. Cumulative FDs, which reinvest the interest until maturity, help build long-term wealth through uninterrupted compounding. A non-cumulative bank deposit provides regular interest payouts, which helps manage short-term financial needs without tapping into the principal amount.
Strategies for Diversifying with Fixed Deposits
Here’s how to effectively diversify your portfolio using FDs:
- Varying Tenures: Choose FDs with different tenures. Short-term FDs (e.g., 3 months) provide liquidity, while long-term FDs (e.g., 5 years) offer higher interest rates. Balancing both ensures flexibility and optimal returns.
- Interest Payout Options: FDs allow various interest payout options: monthly, quarterly, or at maturity. Select the one that aligns with your cash flow requirements. Monthly payouts can supplement your regular income.
- Multiple Banks: Spread your FDs across multiple banks. This reduces concentration risk. If one bank faces financial difficulties, your other FDs remain unaffected.
- Laddering Strategy: Implement an FD laddering strategy. Invest in FDs with staggered maturity dates. As each FD matures, reinvest it or use the funds as needed. This strategy maintains liquidity while maximizing returns.
Key takeaways
Diversifying your FD portfolio is about not putting all your eggs in one basket. It protects your investments against the volatility of a single bank, helps you leverage different interest rates, and maintains liquidity through staggered maturities.
Remember that the goal of diversification is not just to increase wealth, but also to protect it. So, adopt a well-thought-out diversification strategy with fixed deposit and let your hard-earned money yield the best possible returns while minimising risks.
