Fixed Deposits Vs Recurring Deposits

Fixed Deposits and Recurring Deposits are two most commonly leveraged debt based investments used by 90% of the investors in India and abroad. Off late, many of my followers have asked me various questions pertaining to the benefits of investing in either of them and what they should choose and why. So, this post is for all of them.

What is a Fixed Deposit (FD)

A fixed deposit (FD) is a financial instrument provided by Indian banks which provides investors with a higher rate of interest than a regular savings account, until the given maturity date . It may or may not require the creation of a separate account. It is known as a term deposit or time deposit in Canada, Australia, New Zealand, and the US, and as a bond in the United Kingdom.

What is a Recurring Deposit (RD)

Recurring Deposits are a special kind of Fixed Deposits offered by banks in India which help people with regular incomes to deposit a fixed amount every month into their Recurring Deposit account and earn interest at the rate applicable to Fixed Deposits. It is similar to making FDs of a certain amount in monthly installments.

Benefits of FD over RD
We will not be discussing all the available benefits of Fixed Deposits, but will keep our focus on what makes sense in relevance to Recurring Deposits.

• Fixed deposits benefit more from the power of compounding because you invest a lump sum. Therefore, when interest rates on both are the same, fixed deposits score over recurring deposits. And when a fixed deposit offers higher rates, it wins hands down — thanks to both better returns and better compounding effect.
• As an example, say, a bank offers 9 per cent annually on both their fixed deposit and recurring deposit of one-year tenure. The interest income is usually compounded on a quarterly basis. So, if you invest Rs 12,000 in the fixed deposit, you get Rs 13,117 at maturity at the end of one year. On the other hand, a deposit of Rs 1,000 each month for 12 months (totaling Rs 12,000) in the recurring deposit will accumulate to Rs 12,597 at maturity, Rs 520 less. The reason is simple. In the fixed deposit, the entire Rs 12,000 earns interest from the start, while in the recurring deposit each Rs 1,000 earns interest only after the installment is deposited.
• The benefit of early start and better interest rate works in favor of the fixed deposit. The longer the tenure of the deposit, the greater is the benefit. Fixed deposits benefit more from the power of compounding. 
• Long-term fixed deposits (five years or more) with a scheduled bank are eligible for tax deduction up to Rs 1.5 Lacs. This improves the effective return on such deposits. No such tax break is available on recurring deposits. Tax saving in these cases, is a part of Section 80C which currently has an upper limit of Rs. 1.5 Lacs. 
• If you do not deposit an installment, the bank may charge you a penalty. State Bank of India, for instance, charges Rs 1.50 for every Rs 100 a month for non-deposit of monthly installments on recurring deposits with tenure of five years or less. Further, if you do not make deposits for an extended period, banks may close your recurring account.

Well, all this is with the assumption that you have the lump sum money to deposit. In case you do not have a lump sum, but rather a regular inflow of money, then you may want to go for RD or for laddering of fixed deposits.

Benefits of RD over FD

• There is no tax deducted at source (TDS) on the interest earned on recurring deposits. In a fixed deposit, if the interest income exceeds Rs 10,000 in a year, the bank will deduct tax at source and pay you only the balance. 
• But the "no TDS" rule does not mean that the interest income on recurring deposits is exempt from tax. Income on both fixed deposits and recurring deposits is taxable, and certainly you have to pay taxes on both (less, of course, the amount already deducted by the bank). The only benefit is that you can withhold your tax payment till the end of your RD, but you will have to pay every penny.
• It usually can be converted into a SIP format and can enforce discipline from your end.

Should you Ladder your FDs or go for RDs
If you do not have sufficient funds at the beginning and can invest only in installments, then you have a choice whether to go for a recurring deposit or go for creating a ladder of FDs. 

I personally opt for Laddering of FDs because:

• They give me more flexibility as there is a regular maturity of fixed deposits once you have created a ladder. This provides liquidity, which is important for a portfolio, e.g. it helps me if i want to switch my investments between stocks and FDs and vice versa depending on the market conditions.
• I can choose the exact "special rate" of interest by opting for special days like a 1 yr 15 day deposit gives me 0.5% more than a 1 year deposit. Awesome, isn't it?

Cheers

Manoj Arora

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