Best time to book FDs is from now to 6 months but stay away from floating FDs

Investment returns for floating rate FDs are based on a reference rate, such as the repo rate of the Reserve Bank of India (RBI) or a Treasury Bill yield. In contrast to a regular Fixed Deposit (FD), where the interest rate is fixed for the duration of the deposit, the interest rate for floating fixed deposits is not fixed and instead keeps shifting on the basis of a reference rate, which gets reset regularly during the term of the deposit.

However, the interest amount is paid on the floating FD quarterly on the last day of every month. The Reserve Bank of India left the key repo rate unchanged at 6.5 per cent for a fifth time in a row. “We expect the Central bank to maintain a prolonged pause on monetary policy rate until August 2024 and opt for a pivot thereafter with visibility on the durability of the 4% inflation target getting better,” QuantEco Research said in a note on Friday’s monetary policy statement.

Is it a good time then to lock in those regular fixed deposits or should one opt for a floating FD?

A floating fixed deposit works best when interest rates are rising. However, RBI has not increased the repo rate since the last five review meetings and is not expected to do so until August 2024. 

"Investing in Floating rate Fixed Deposits (FDs) during times of rising rates can be advantageous, offering an attractive investment opportunity. It's crucial to note that a floating rate FD will mirror the interest rate scenario. When interest rates are rising, floating rate FDs appear quite appealing, but they might lose their allure once we transition into a declining interest rate period. You may consider choosing floating rate FDs for a maximum duration of two to three years. Beyond this period, investors might face the risk of potential interest rate reductions. Therefore, it's prudent to explore long-term fixed rate FDs when interest rates are at their peak, securing a higher interest rate for the long haul," explained Adhil Shetty, CEO of Bankbazaar.

In other words, currently the chances of fixed deposits rising further are slim as they are already at their peak.  It is unlikely that rates would go up further so floating rate FDs might not help, especially if your investment horizon is more than one year. 

Lock in the high interest rate FDs but stay clear of floating FDs

"Over the last 5 outings, the monetary policy committee has not changed the key policy rates to tame the retail inflation. We expect that the key policy rates will come down post-Q2 2024. This reduction will have a downward impact on the FD returns of various banks, small finance banks, and NBFCs. Therefore, the best time to book FDs is from now to the next 6 months, as you can lock your money on high-interest rates. Investors can also build a ladder of FDs with varied maturity periods to fulfil different financial goals," said  Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.

Many banks try to sell floating-rate FDs at marginally higher interest rates. These FDs are best avoided because the yield will be much less. Kulkarni explains this with an example:

 Suppose two investors need to book a three-year FD of Rs 1 lakh. The first investor opts for an 8.5% fixed interest rate per annum, and the second takes an 8.8% floating rate. Both these FDs reinvest the interest amount.Let us further assume that the interest rate on floating FD is reduced to 8.5% after one quarter, 8.3% after the second quarter, and 8.2% after a year. After that, the rates remain stable for the entire tenure. At the maturity, the first investor would receive Rs 1,28,702, while the second would get 1,27,916. The difference would be much more for a larger corpus.

"Caution is advised against floating rate term deposits (which get reset based on interest movement) due to their variable interest rates, which expose investors to market fluctuations; few have bank lock-in periods. Fixed FDs offer stable returns, shielding investors from interest rate volatility. Additionally, premature withdrawal penalties in floating-term deposits can erode gains. Therefore, a well-planned fixed deposit strategy, emphasizing stability and aligning with financial objectives, proves advantageous for risk-averse investors seeking consistent returns," said Abhijit Roy, CEO, GoldenPi. 

What is the ideal FD strategy at time when interest rates appear to have peaked?

FD laddering is a strategy to give you better average returns on your savings while providing liquidity regularly. For example, you could open FDs with 1-year, 2-year, 3-year, and 5-year tenures. This diversification ensures that a portion of your investment matures each year. As each FD matures, you can choose whether to renew it or withdraw your funds. If inflation is low, you can reinvest the maturing FD at prevailing interest rates. 

"If interest rates have risen, you can benefit from the prevalent higher rates. This gives you a way to get better average returns than when you’re locked into a single low-rate FD for the long term. If you initiate a FD with a sum of Rs 1 lakh, set for a one-year term with a 5% interest rate, and there's an inflation rate  of 6%, your returns would be insufficient to counter the inflationary impact. On the contrary, employing a strategy where you open a series of FDs, each with increasingly higher interest rates over time, such as 5%, 7%, and 8% for successive years, would better enable you to outpace and mitigate the effects of inflation," said Shetty.

It is also wise to compare the last two to three years' interest rates. Opt for the highest rate and make multiple deposits at different tenures. If the rate increases you always have the option to make use of matured funds. You should also opt for the FDs where pre-withdrawal has no penalties. This strategy will help you customise as per the market conditions.

 "An effective fixed deposit (FD) strategy for investors involves careful consideration of tenure, interest rates, and financial goals. Opting for longer tenures often yields higher interest, while aligning maturity dates with specific financial milestones enhances planning. Investors can also opt for Corporate FDs Which are high in credit ratings, and give an interest rate in the range of 7-9% with additional benefits to senior citizens. Ultimately, due to the constant fluctuation in the rates, the decision lies on the investor based on their risk tolerance and financial objectives," said Roy.