A fixed deposit (FD) is a financial instrument provided by Indian banks which provides investors with a higher rate of interest than a regular savings account, until the given maturity date . It may or may not require the creation of a separate account. It is known as a term deposit or time deposit in Canada, Australia, New Zealand, and the US, and as a bond in the United Kingdom. They are considered to be very safe investments. Term deposits in India is used to denote a larger class of investments with varying levels of liquidity. The defining criteria for a fixed deposit is that the money cannot be withdrawn for the FD as compared to a recurring deposit or a demand deposit before maturity.
Introduction of FD Bonds:
A bond is a negotiable debt security under which the issuer borrows a given amount of money, called the principal amount. In exchange, the borrower agrees to pay fixed amounts of interests, also called the coupons, during a specific period of time. Everything is well defined by the bond contract: the coupon rate is the interest rate that the issuer pays to the bondholder and the coupon dates are the dates on which the coupons are paid. Besides the issuer will repay the total amount of the principal when the bond will reach what is called maturity (or maturity date). In short, a bond is a securitized loan.
Why should buy?
Bond funds make bond investing easy for average investors. Investing in bonds profitably could soon be a different story. Now you know bond investing basics. Few average investors actually invest in individual bond issues like XYZ above. Instead, millions of Americans get into bond investing the easy way with bond funds. These funds pool investor money and manage a collection (portfolio) of these securities for their investors. When you invest money in a bond fund your money buys shares, and you then own a small part of a large portfolio of bonds. The fund actually owns the securities and buys and sells bonds on an ongoing basis. They pass the interest income on to investors in the form of dividends, and usually charge less than 1% a year for their services.
As a bond fund investor you can have your interest income send to you periodically or you can have these dividends reinvested automatically to buy more fund shares. The value or price of your shares will fluctuate along with the price fluctuations in the individual bonds held in the portfolio. You can buy or sell fund shares on any business day. You are not locked in. Now you know bond fund investing basics. So, here is the rest of the story. Remember, when you own bond funds you have an investment in bond securities. Whatever happens in the bond market and to the value of the bonds in your fund portfolio translates to gains and losses for you.
For whom it is suitable?
What is the maturity of the bond?
Another way to ask this question is How long will you need to hold the bond before you can get your money back? It is very important that you consider how soon you will need the money whether it will be used for a vacation, a new home or to fund your retirement. Another important factor to consider on this subject concerns liquidity. Is there a ready market for the bond if you need to sell it prior to the maturity date? Or will you need to find another means to fund that unforeseen opportunity?
Does it have early redemption features such as a call date?
Many investors have either been unaware of or have overlooked the call features on their bonds and other callable fixed income products. Many investors purchased bonds paying very attractive yields when rates were higher only to have them called away during the recent low interest rate environment. If you are counting on a high yield bond to provide the income that you need to buy your groceries you may be a bit surprised when your bonds are called away and you are looking at reinvesting in new yields that will barely cover a trip through the drive through window at your local fast food restaurant.
What is the credit quality?
What is the rating? Is it insured? Don not get too excited about that 7% yield until you find out whether the bond is investment grade or if it is junk! Credit quality is very important. If you can find a bond that is triple-A rated with insurance guarantying that you will receive all of your interest payments and all of your money back at maturity you might be happy. But, if you just blindly jumped on a bond that was paying 7% because it had a great yield you may be surprised to find out that the company might be on the verge of bankruptcy and you may never see your money again.
Investors should keep in mind that credit ratings may change after you purchase a bond or most other investments. Does Enron ring a bell? Many brokerage firms had buy ratings on Enron is common stock and Standard & Poor is even showed an A- rating on Enron is Common stock as late as October 2001. Unless you have been living under a rock you have probably heard what has happened to investments in Enron.Credit quality of the insurer is important too! While having an insured bond often lends us great comfort, the insurance on the bond is only as good as the quality of the company that is insuring it.
What is the interest rate?
How much am I receiving to lend my money to the issuer? Remember that you are actually loaning your money to someone else and you should be properly compensated. Is the interest rate appropriate for your time horizon? If you are receiving 3% on a two year bond you may be satisfied with the yield but you probably would not be satisfied with the same yield on a thirty year bond.
What is the price?
Many investors get so excited when they see a high yield bond that they forget to consider the price! A bond may originally have cost $1000 to purchase but with the changes in interest rates (as well as other factors) over time; the bond may be worth more or less than when originally issued. If a bond pays 7% interest but you pay $1120.00 to purchase it, the yield is not so attractive.
What are the Risk?
Risk #1: The economy
The most pressing risk of investing in the stock market is that the economy can always take a downturn. A combination of factors can cause the market indexes to lose significant percentages. In fact, we are just now returning to the levels of the pre-September 11 market.
In general, the economy is just going to happen. There is nothing you can do to control it. Most young investors are best off if they just ride out the downturns. Investing for the long run really helps. In fact, many investors use the downturns to pick up stocks that are good solid companies at a slightly lower price.
If you are an older investor, a major downturn of stocks can be devastating if you haven not moved the significant portion of your portfolio from the stock market and into bonds or fixed-income securities. This is where management and risk tolerance really comes into play. Don not put things off. You never know about the economy.
Risk #2: Inflation
Inflation will always be a risk to investors. It hits everyone, no matter their savings or portfolio size. It will destroy the value of your dollar. It is the cause of recessions. We like to believe that we can control inflation, but sometimes the cure is just as bad as the problem. Higher interest rates can help to mitigate inflation, but they can also hit the market in a negative way.
Investors usually retreat to hard assets, such as real estate, when inflation gets high. But in most cases, stocks are usually a pretty fair protection against inflation. the idea is that companies have the ability to adjust prices to the rate of inflation. There are some industries and sectors that adjust more than others, so you should diversify your investments. Investors are hurt by inflation by the erosion of the value of the dollar. Those on a fixed income will suffer the most. That is why it is a good idea to keep a portion of your assets in stocks, even when retired.
Risk #3: Market Value
Market value risk occurs when the market turns against your investment, or even ignores your investment. For example, the market often chases the next hot stock, leaving many good companies behind. Some investors will use this to their advantage -- buying stocks before the market realizes their potential.
However, it can also cause your investment to flat-line while other stocks rise.
Diversification between different sectors of the economy is key. When you spread out your investments, you have a better chance in participating in growth.
Risk #4: Becoming too conservative
There is nothing wrong with being careful. However, you can go too far in how conservative you are. If you never take any risks, it is probably that you will not reach your investment goals. You know that investing in a savings account for the next 20 years is not going to give you enough of a return to retire. You have to be willing to accept some risk. Just keep it under a close eye.
When you know the risks of investing and research your stock potentials, you make decisions that help you not only mitigate risk, but eliminate a large portion of stress as well.