Core Concept - Fixed Deposit
What is a Fixed Deposit?
A fixed deposit is a lump sum of money you invest with a bank or the government for a fixed term (anything from three months to five years). Importantly, the rate of interest you will receive is also fixed and given to you ahead at the outset. Fixed deposits are considered as one of the safest investment options.
Why invest in a Fixed Deposit?
- Certainty - This is one of the great advantages of a fixed deposit investment compared to other investment options. You know from the outset (1) the amount of interest you will receive as well as (2) the timing of interest payouts in advance. Compare this to an investment in the stock market. There is no way of knowing what rate of return you will get in the next 3 or 6 months.
- Flexible payment terms - Banks typically allow you to receive interest payments (e.g. monthly, quarterly, half-yearly, annually or end of term). This allows you to set up the investment to meet your cash flow liquidity requirements. Example: Lets assume you need to buy a new car in nine months time. You can choose to pay out all your interest at maturity. Investing in a fixed deposit for this goal is ideal as you are picking up considerably more yield (compared to leaving it in your savings account) & it gives you certainty of making the car payment in nine months.
- Beat Inflation - inflation is your public enemy numero 1. If you have money sitting idly in a current account, you are effectively losing money. This is because the rates of return given to you on savings accounts do not keep up with inflation & so over time you are losing buying power of your hard earned cash. Fixed deposits offer rates which beat inflation. The rates offered by the banks even for the shorter terms are beating inflation - see 3 month rates here. This is because banks need to comply with Basel requirements and will pay you substantially more (relative to savings account) to fix your money for 3 months or longer.
- Ideal for emergency fund - fixed deposits can be an ideal addition to your emergency fund to earn more yield. Do not put all your emergency fund's money into fixed deposits, but 20-30% is a good number to invest in higher yielding deposits.
Disadvantages of a Fixed Deposit
- No access to funds over term - this is the biggest disadvantage for fixed deposits! For the entire agreed term, you will not be able to wthdraw your capital! That is why banks pay you proportionately more compared to quick access accounts. There are still ways to withdraw before the maturity if you really need the money, but you will be liable for considerable penalties.
- Monthly contributions are not allowed - fixed deposits do not allow top-ups. So if you are looking to put in an extra R500 per month - this is not allowed.