Short-term vs. Long-term FDs: Which Offers Better Returns?

Fixed Deposits (FDs) are a common choice for many people when investing. FDs are an excellent choice for people searching for a low-risk investment since they provide a dependable and safe method to receive income on your cash. But not every FD is made equally. You can choose from two different types of FDs: short-term and long-term. The ideal option for your investing goals must be chosen by you, keeping in mind their specific offers, benefits, and drawbacks.

  Understanding FDs:

FDs are investment tools that banks and Non-Banking Financial Companies (NBFCs) provide. In FDs, investments are made for a set period at an applicable interest rate. FDs with varying tenures can be opened for short-, medium-, and long-term. The short-term FD program offers terms as little as seven days and as long as less than five years. Long-term FDs, on the other hand, are often kept for between five and ten years.

FDs usually give a greater rate of interest than other savings accounts. Risk considerations are also minimal as FDs have no market exposure or correlation. Consequently, this is regarded as one of the top investment choices for older citizens and new investors.

  Short-term FD

Short-term FDs are investments that allow people to deposit a certain sum of money for a short period, enabling them to earn interest throughout that time.

  Advantages of Short-term FDs:

● Quick Liquidity: Short-term FDs allow you to access your funds relatively quickly, ensuring financial flexibility.

● Capital Preservation: These FDs offer a safe and secure way to protect your capital while earning moderate FD returns.

● Flexibility: Investors can place their money in short-term FDs for a short period, often from a few days to a few months. This offers more freedom because investors may use their money whenever necessary.

● Regular Reinvestment: To maintain continuous FD returns, investors can reinvest the proceeds of matured short-term FDs, capitalising on potentially higher interest rates.

● Short-term Financial Goals: The ideal way to start small financial savings and reach short-term financial objectives, such as buying a present for a family member, is through short-term FDs.

  Limitations of Short-term FDs:

● Lower Interest Rates: Compared to long-term FDs, short-term FDs may provide lower interest rates, resulting in relatively modest returns.

● Frequent Renewals: To maintain FD returns, you must renew short-term FDs regularly, which can be time-consuming.

● Reinvestment Risk: After a short-term FD matures, reinvesting at a lower interest rate due to prevailing market conditions can result in lower FD returns for the next tenure.

● Lower Compounding Effect: The shorter tenure of short-term FDs limits the compounding effect, leading to lower overall investment growth than long-term FDs.

● Impact of Inflation: Inflation can impact the purchasing power of the returns earned on short-term FDs, especially if the interest rates fail to keep up with the rising cost of living.

● Taxation: The interest earned on short-term FDs is usually taxed at the individual’s applicable income tax rate, which can further reduce the effective FD returns.

  Understanding Long-term FDs:

Long-term FDs have a tenure of one year or more, with some lasting up to ten years or beyond. They are well-suited for long-term financial planning and wealth accumulation. Long-term FDs usually offer higher interest rates, leading to higher returns.

  Advantages of Long-term FDs:

● Higher Interest Rates: Long-term FDs generally offer higher interest rates, enhancing the potential for significant returns on your investment.

● Compounding Effect: The longer tenure allows the interest to compound over time, resulting in compounded investment growth.

● Higher Stability: Long-term FDs provide a stable and secure investment option, shielding investors from short-term market fluctuations.

● Long-term Planning: With a longer tenure, investors can align long-term FDs with specific financial goals like buying a property, funding higher education, or planning retirement.

● Consistent Returns: Long-term FDs offer consistent returns over the tenure, providing a steady income stream for financial planning and budgeting.

● Avoiding Reinvestment Hassles: The longer lock-in period of long-term FDs reduces the need for frequent reinvestment decisions, saving time and effort.

● Retirement Planning: Long-term FDs can serve as an essential component of retirement planning, ensuring a reliable source of income during retirement years.

  Limitations of Long-term FDs:

● Opportunity Cost:  When considering long-term investing strategies, you should know your corpus will be locked up for years. You run the risk of passing on possible short-term possibilities.

● Inability to experiment with other instruments: You may choose the greatest long-term investing strategies to avoid losing money shortly. This may now restrict your exposure and prohibit diversification.

● Limited Liquidity: Accessing funds before the maturity of a long-term FD can be challenging and may involve penalties or loss of interest.

● Changes in Interest Rates: If interest rates increase significantly after investing in a long-term FD, investors may miss taking advantage of higher rates.

● Tax Implications: The interest earned on long-term FDs is subject to taxation, which can impact the overall post-tax returns.

● Lock-in Period: During emergencies or unforeseen circumstances, the lock-in period of long-term FDs can limit access to funds when needed the most.

  Which Option Offers Better Returns?

The choice between short-term and long-term FDs depends on your financial goals and risk appetite. Short-term FDs are a practical choice if you require quick access to your funds or anticipate short-term needs. On the other hand, if you have long-term financial objectives and seek higher returns, long-term FDs are more suitable.

To maximise returns and maintain liquidity, consider creating a diversified FD portfolio. Allocate funds to both short-term and long-term FDs based on your financial requirements. This strategy enables you to enjoy the benefits of both options while managing risk effectively.

Conclusion

Individuals may use both deposits to accomplish various objectives and build a substantial financial buffer. A person can opt to invest in a 1-year FD and receive interest if they wish to save money for, say, a year from now but don’t want to retain the money in an ideal situation. However, it is prudent to choose long-term FDs with a 5-year lock-in duration if interest rates decline. One may develop a solid financial strategy over the long run by adopting a disciplined approach to investing in both short- and long-term FDs.