Fixed deposits are a favourite among Indian investors, and they offer predictable returns on maturity. You can open an FD without many hassles and moreover, do not have to worry about volatility in the market. However, once you park your funds in an FD, they are locked in for the period of the tenure. Making a premature withdrawal of fixed deposit attracts a fee, typically 0.5 – 1%.
How should you address this apparent drawback of the fixed deposit? Withdrawing your FD is not a great idea, as the effective interest rate you are left with may not be competitive enough to combat factors like inflation. The best way is to employ certain strategies that bring in an element of liquidity. Here are 5 ways to avoid a premature withdrawal of a fixed deposit.
Opt to ladder your fixed deposits
The laddering strategy is an intelligent way to maintain periodic liquidity and avoid the penalty associated with the premature withdrawal of fixed deposit funds. The idea is that you diversify your funds in multiple FDs of varying tenors instead of placing all your money in one particular FD.
Consider that you want to invest ₹1,25,000 and your normal strategy would be to open an FD for 5 years. Here, you are without liquidity for the entire period. Instead of this, you could invest in 5 FDs, each worth ₹25,000, and have the deposits mature after terms of 1, 2, 3, 4, and 5 years. This way you receive a payout every year. If you do not need the funds that have matured from the 1-year FD, you could invest them again in a 5-year FD. In this way, the cycle can continue.
Consider a non-cumulative FD
With a cumulative FD, the interest you earn through the tenure is reinvested with the principal. This allows you to earn interest on interest and maximise the power of compounding. Your returns are the highest when you opt for a cumulative FD. However, you must wait till maturity to enjoy the interest you have earned.
Investing in a non-cumulative FD is the alternative. Here, you can opt to receive interest payouts every quarter, month, half-year, or year. You achieve liquidity, but your overall gains are lower. Also remember that the interest rate on FDs depends on the payout frequency. Higher payout frequencies tend to attract lower FD rates.
In general, a non-cumulative FD is ideal if you have fixed and recurring expenses that you need regular assistance for.
Take a loan against your FD
Financial institutions offer a facility wherein you can offer your FD as collateral to receive funds. This can be a convenient way to obtain liquidity without hampering your investment. The rate of interest on the loan against FD ranges between 1 and 2%, more than the FD interest rate. Moreover, you should not have to worry about the processing fees associated with other loans.
However, remember that the tenure of the loan cannot exceed the maturity date of the fixed deposit. Before taking a loan against FD, you may want to consider a cost-benefit analysis. When doing so, bear in mind how a premature withdrawal of fixed deposit affects your maturity value.
For instance, consider you invested ₹1,00,000 in an FD for 3 years at a 7%. Also, consider that the rate for 2-year FDs is 6.5% and the penalty is 1%. Now, if you withdraw the FD after 2 years, the effective rate you get is 6.5% – 1% = 5.5%.
Use the sweep-in facility
With this option, you transfer excess money in your savings or current account to an FD account. The sweep-in facility offers you a blend of a savings account and fixed deposit, allowing you to earn interest on the excess amount at an improved rate.
So, for instance, if you want to keep ₹1 Lakh in your savings account and your current balance is ₹1.5 Lakhs, you can have the balance ₹50,000 transferred to your FD account. The advantage is that the amount in the FD earns at a superior rate, and you can dip into these funds without worrying about premature withdrawal penalties.
Invest for a shorter time period
Most FD issuers offer a flexible tenure over which you can choose to have your funds mature. In general, the interest rate on FD increases as the tenure increases. However, the rates peak at about 3 years for many issuers. So, there is no real need to always opt for the maximum tenure. This way, your FD matures at the best rate possible, and you can choose to use or reinvest your funds post-maturity.
Now that you know how to avoid premature withdrawals on FDs, choose the best issuers when investing. There are many options you can opt for, and you may even find online services that simplify this process.
