Amidst market fluctuations, regular FDs might not always offer the most favourable returns. This is where Floating Rate Fixed Deposits (FDs) come into play. Unlike other FDs that offer a fixed interest rate throughout the tenor, these FDs have an interest rate that varies based on a benchmark rate. Here are the key factors you should know before investing in floating-rate fixed deposits.
A floating rate fixed deposit is a type of FD where the interest rate is not fixed but is linked to a benchmark rate. This means that the interest earned on the deposit will fluctuate in line with the changes in the benchmark rate. When the benchmark rate increases, the interest rate on the FD increases, and vice versa.
Common benchmarks include:
- Repo Rate : The rate at which the RBI, the central bank of India, lends money to commercial banks
- Treasury Bill Rate : The yield on short-term government securities
- MCLR (Marginal Cost of Funds Based Lending Rate) : The minimum interest rate that a bank can lend at
It is essential to understand the chosen benchmark for the floating FD rates, as this will directly impact your earnings.
Interest Rate Volatility
The primary advantage of floating rate FDs is their potential to offer higher returns during periods of rising interest rates. Conversely, the interest earned could decrease if the benchmark rate falls. This variability could make such FDs suitable for investors who expect interest rates to rise in the future and are willing to accept the risk of fluctuating returns.
Tenor Flexibility
Floating rate FDs typically come with tenors, ranging from a few months to several years. However, the ideal tenor for a floating rate FD depends on the interest rate outlook. If interest rates have surged, a long-term fixed deposit might be beneficial. This can help investors capitalise on the increasing rates. Meanwhile, if rates are expected to fall, a shorter tenor might minimise the impact of the drop in rates.
Interest Rate Reset Frequency
The floating FD rates are usually reset at regular intervals, such as monthly, quarterly, or half-yearly. A ‘reset’ is the moment when the interest rate on your FD is recalculated to align with the current benchmark rate. This reset can happen every few months or once a year, depending on the terms of your FD.
For example, if your FD’s interest rate is set to reset every 3 months, the bank will check the benchmark rate every 3 months. The interest rate of your FD is then adjusted accordingly. If the benchmark rate has increased, the interest rate on your FD will increase at the reset. If the benchmark rate has decreased, your FD’s interest rate will decrease at the reset. Thus, the frequency of these resets plays a major role in calculating the interest earned.
Comparison with Regular FDs
It is essential to compare the potential returns of floating-rate FDs with regular FDs before investing. While these offer the potential for higher returns in a rising interest rate environment, traditional FDs provide predictable and stable returns. The decision should be based on your risk tolerance and expectations of future interest rate movements.
Taxation
The interest earned on floating rate FDs is taxable under the Income Tax Act, 1961, just like other FDs. The interest income is added to your total income and taxed according to your income tax slab. Additionally, Tax Deducted at Source (TDS) is applicable if the interest income exceeds ₹40,000 in a financial year. The limit has been pushed to ₹50,000 for senior citizens. However, opting for a tax-saving FD which comes with a 5-year lock-in period could help you save more tax u/s 80C.
Institutional Credibility
Before investing in an FD, ensure the issuing bank or NBFC is credible and financially stable. Look for institutions with high credit ratings and a good reputation. This reduces the risk of defaults and ensures your investment remains safe.
Current Market Conditions
The decision to invest in a floating-rate FD can depend on the current and expected market conditions. During periods of economic growth and inflation, interest rates are likely to rise, making these FDs more attractive. Conversely, during economic downturns, interest rates may fall, reducing the appeal of floating rate FDs.
On the other hand, regular FDs come at fixed interest rates. This ensures guaranteed and stable returns.
Portfolio Diversification
Including floating rate FDs in your investment portfolio can enhance diversification. They provide a balance between the security of traditional FDs and the potential for higher returns offered by market-linked instruments. This diversification can help in managing overall portfolio risk.
Floating Rate Fixed Deposits offer a unique opportunity for investors looking to benefit from rising interest rates while maintaining the safety of an FD. Understanding the key factors such as benchmark rates, interest rate volatility, tenor flexibility, and taxation is crucial before investing.
By thoroughly evaluating these aspects and considering your risk tolerance, you can make an informed decision. Always remember to invest with credible issuers and stay informed about market conditions and regulatory changes. This will help you maximise your returns from floating-rate fixed deposits.
