Fixed Deposits could get stuck forever- Some Pointers if You have to
People losing money through Fixed Deposits keep happening at an alarming rate. So thought it would be useful to bring home some pointers.'
Fixed Deposits with companies have always been an avenue for savers. It is essentially an instrument of ‘trust’. You place your money for periods ranging from six months to five years. Interest is paid quarterly, half yearly, annually or compounded and paid with principal, at maturity.
I have also seen people splitting their deposits in to chunks of Rs.45,000/- and put it in to many companies, to escape the TDS net. In doing so, they end up putting money in to high risk areas and the need to follow up with many companies for interest, repayment etc.
Most often, we do not do any homework about which company we give it to. We either go by broker recommendation or by our perception of the company or on the basis of interest rate offered.
Fixed Deposits with companies are one of the riskiest investments. There are hundreds of companies where people lost money due to default. Leasing companies in the eighties were amongst the biggest to default.
Unlike any other borrowing by a company, Fixed Deposits are not regulated or vouched for by anyone. The law simply allows every public limited company to raise money from the public. This is as good as permitting them to carry on banking. There is no security or any guarantee provided by anyone. In the event the company goes in to liquidation, the Fixed Deposit holder is the last in queue.
However, FDs do offer the highest rate of interest as compared to other forms of investments. Perhaps they offer the only returns that help you to battle inflation. If inflation is at ten percent, a bank fixed deposit that gives you eight percent or nine percent means that you actually erode your purchasing power. The risk that we assume is that in a company FD, we may lose the amount invested if we choose without thought and homework. Just pause to think. Why is a company raising money through this route? Surely it must be due to reasons of poor credit standing or bankers’ reluctance to lend them more money.
There is one class of companies that raise FDs on a regular basis from the public. They are NBFCs and Housing Finance Companies. Here the key issue is that whilst you put in your money for one to three years, they may be lending for longer tenures. In essence, unless they keep finding new investors on a regular basis, they will have problems of finding money to repay. If the Fixed Deposit tap were to be suddenly turned off, the NBFCs and Housing Finance Companies with less than high reputation or credit standing will be hard put to repay. That is what happened to the leasing companies in the eighties. Only a handful survived.
If you have to invest in Fixed Deposits, look at the following:
i) A credit rating that is at least of AA (Double AA) level, signifying “High Credit”quality. And ideally they must have this rating from a minimum of two well known rating agencies.
ii) Keep the duration to one year ideally, ask for repayment and then reinvest. If the credit rating is the highest (AAA or Triple A) from two agencies, then you could consider a longer duration.
iii) Stick to companies that can service your investments in the city you live in. That makes it easier to follow up in case of need.
iv) Do not get tempted by higher returns or incentives that may be offered. If someone is offering a high rate of interest, surely the risk is very high.
v) If there is a choice between ‘listed’ debentures and fixed deposits, opt for the debentures. Presently, on listed debentures, there is no TDS. Listed debentures can be bought through a broker.
vi) Never go in for automatic renewal of deposits. Take the repayment and then re-invest, if required. This will ensure that you check the repayment systems also.
vii) Be very sure that you can afford to wait for the maturity period. Whilst some companies may offer premature withdrawals, it is better to be safe than sorry.
viii) Avoid new companies or small sized companies. Go for companies with ten to fifteen years of standing and reputation in the industry.
ix) Check on the internet for any news about the company that may warn you for any signs of trouble. Google is a fantastic resource for checking news.
x) Avoid unlisted or private limited companies or industries that do not have regular cash flows (engineering, real estate, infrastructure, capital goods etc).