Five risks associated with investing in fixed deposits

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Investing in fixed deposits is always considered a safe thing to do, but there are risks associated with it just like any other financial investment.

These are the 5 risks of investing in FDs

Default risk

Although it is rare, there exists the possibility of default of repayment of your money invested in a fixed deposit along with the interest amount by the bank. However, deposit money and interest worth up to Rs 5 lakh per person per bank account is guaranteed by the Deposit Insurance Credit Guarantee Corporation (DICGC). Any amount over and above Rs 5 lakh per individual is subject to default risk.

Liquidity risk

You can break your FD before the maturity date arrives, but that comes with a catch – a penalty fee, which varies from bank to bank. In the case of a 5-year tax-saving fixed deposit, the investor cannot withdraw the proceeds before the completion of its tenure is over. Though this tax saver scheme offers income tax benefits to the customers, it comes with a drawback.

Inflation risk

Returns from fixed deposits are mostly the same as inflation rates or a little higher. But there are times when they are lower than the prevailing inflation rates. When that happens, the net value of your FD investment is reduced to nearly nothing after accounting for inflation. This results in the erosion of the wealth of the investor.

Interest rate risk

Interest rate risk comes in when you lock in at a lower interest for a 5-year tax saving FD. If somewhere in between those five years – FD interest rates shoot up, then you lose out.

Reinvestment risk

In a declining interest-rate scenario, FDs that are due to mature soon, leaves investors with a tough task—to go for reinvestment of these fixed deposits and the interest earned on them or not? Because they will get offered a lower rate of interest that is prevailing at the moment.