Rising interest rates have prompted many investors to prematurely withdraw and reinvest their current FDs. However, is this idea worth the hype?
The State Bank of India (SBI) recently increased its fixed deposit interest rates by 80 basis points. This is not the first bank or financial institution that has increased its deposit rates in the recent past. Since the Reserve Bank of India (RBI) announced rate hikes to combat inflation, banks have increased deposit rates to boost liquidity and, as a result, creditworthiness. Apart, the minimum deposit size has also come down, thus, benefiting more depositors.
SBI increasing its fixed deposit rates is not a lone case in the fintech world. Before this, HDFC Bank and Bajaj Finance had hiked up their FD rates, thus, allowing more customers to seize the benefit of higher interest rates.
Gradual investing in FDs
Many investment advisors are now recommending to their clients that they spread out their fixed-income investments over the next few months. This FD laddering strategy has been tried and tested for starting multiple FDs at different maturities. Rather than committing the entire savings amount to one FD, this can be accomplished by investing in three different FDs at equal or similar time intervals. For example, you may invest in one FD that matures within six months, a second FD that matures within a year, the third FD that invests in the coming one and half years and so on and so forth.
This way, the short-term FDs can either be set on an auto-renewal mode or be renewed and locked in for subsequent tenures at higher interest rates as when the banks announce. The interest rates on long-term FDs are not too high, which is why investors must now lock their money in short-term FDs or wait for the announcement of higher interest rates on long-term FDs.
Given our position in the global inflation web, it is reasonable to assume that the interest rate cycle is currently on an upward trajectory, though it is unclear how far interest rates may rise. Assuming that the good times are over and that there will be no more interest rate hikes would be foolish. This again explains why you must not lock your FDs for long tenure but restrict them to short-term investments.
Should you withdraw to reinvest?
Many investors wonder if they must withdraw their existing FDs to reinvest them at higher interest rates. They want to know if they can maximise their returns by using this investment strategy, especially if their FDs are tied to lower interest rates.
Though this idea may seem innovative and an out-of-the-box way to increase your interest earnings, withdrawing your FDs involves paying penalties and tax on the interest income too.
If you withdraw your FDs prematurely, you will first lose out on the interest income. To make matters worse, banks would levy penalties in addition to the tax deducted at source (TDS) on interest income earned to date.
This means that whatever extra income you earn from the high-interest rates will be insignificant when compared to the amount you will lose in penalties and taxes, explaining why withdrawing your existing FDs to reinvest at the current interest rates is pointless.