Monday, May 16, 2011

Fixed Deposits: To Switch or not to Switch?

Fixed Deposit rates have in the recent 2 weeks gone up significantly. If you remember the rate offered by banks last year (May 2010) for a 2 - 3 year Fixed Deposit, it was around 7 – 7.5%. The current rates offered are significantly higher at almost 9% with some banks offering even up to 9.5% for a 3 year fixed deposit (check the section on Fixed Deposits to see the table with details of bank Fixed Deposit rates). So the question now is – ‘Do I switch my fixed deposit by foreclosing my Fixed Deposit and re-investing it at the higher rates?’ This question may seem a no-brainer and may seem ridiculous because you can see that you can clearly earn a higher return! However before you take the plunge you must look closely at your current Fixed Deposit and ask yourself the following questions:

1. What is the pre-closure penalty that I will be charged?

      2.   When will my original fixed deposit mature (check the tenure)?

1. Pre-closure penalty: When you put your money in a Fixed Deposit after listening to your friendly manager, you probably did not ask about and neither were you told much about the pre-closure rate, in case you closed your Fixed Deposit before the term ended. The pre-closure rate varies from bank to bank and also may vary depending on how much of the term has passed. This pre-closure penalty is charged irrespective of whether you reinvest in the same bank. Therefore as a depositor it is paramount that you assess whether the new rates that you will receive will cover the penalty that may be charged to you when you pre-close your Fixed Deposit.

2. Tenure of the Fixed Deposit: If your Fixed Deposit term is just about to end, then it may not make sense to pre-close your Fixed Deposit. Also the current 1 year deposit rate available in the market is a maximum of 9.25%. But with pre-closure charges of 0.5%-1%, it doesn’t make sense to break an FD if you are going to reinvest it for less than 2 years, since you wouldn’t be able to get any advantage of a higher return after the pre-closure penalty.

A switching strategy is advantageous if a depositor wants to re-invest for a period of more than 2 years and a depositor should look out for the best deposit rates available and invest accordingly. For a list of deposit rates, check the section on Fixed Deposits.

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