In India, most people deposit their money in Fixed deposits. Though there are many critics of FD for not giving inflation-beating returns, it is a good option to park your emergency funds. But, did you know even FD has risks? Let’s find out. 

Interest Rate Risks

Recently, RBI has hiked the repo rate twice and this has increased the interest rate on FD. This rate hike will apply to all the new FDs and not the existing ones. So, your old FDs will fetch lower interest rates. An obvious solution to this seems that why not make an FD now for five years. This way an FD will earn higher interest for the next five years. But, if the interest rates get hiked further, you have locked yourself with the lower interest rate for the next five years. 

On the contrary, if you do an FD for just a year and if the interest rate falls, you lose a chance to earn higher interest for additional 4 years. So, irrespective of the period, your FD investments are prone to interest rate fluctuations. It is called interest rate risk. 

Liquidity Risks

Another Risk that an FD face is the lack of liquidity. If you are thinking to withdraw your FD before its maturity and then book a new FD with a higher interest rate, then you have to pay premature charges. So, there is less flexibility in withdrawing your funds in the time of sudden need.

There is a smart way where you can invest in FD more mindfully and earn maximum returns. And, this way is ‘FD Laddering’. 

FD Laddering

Let’s understand this with an example. Suppose you have to do an FD of Rs. 4 lakhs, and the interest rate is 5%. Instead of booking a single FD of Rs. 4 lakh, divide this amount in Rs. 1 lakh each and book 4 FDs for consecutive periods. So, your FD Ladder would look like the following:

On the maturity of each FD, you have to renew it for five years. So, after the FD1 matures, it would become FD 5 with a maturity period of 5 years. 

Thus, by booking your FD with consecutive maturity periods, there is zero liquidity risk as there is a maturity date each year. If you require money, you can choose not to renew the FD.

This FD ladder also reduces your interest rate risk. If, after a year, the FD interest rate rises, you can renew it for the next five years at higher interest. If the interest rate increases further, you have FDs maturing each year and can be renewed at a higher interest rate. 

If the interest rate falls after a year, you will get lower interest only on the renewal of FD1. The rest of the FDs of Rs. 4 lakhs will still attract a higher interest rate. 

Every time you renew an FD for the next five years, you would get the tax benefit for that amount under section 80C subject to a maximum of Rs. 1.5 lakhs. 

Conclusion

So, this was how you could earn maximum interest on FD. Further, to reduce risk, you can book these FDs in different banks. RBI does insurance of all the deposits in a savings account, current account, and Fixed deposit. So, if the bank defaults, the RBI will pay you money. But, this insurance limit is Rs. 5 lakhs for each bank. So, by opening FD accounts of not more than Rs. 5 lakhs in each bank, you can avail of this insurance.