Recurring deposit (RD) is a form of term deposit offered by banks and post offices through which a fixed amount can be deposited periodically by individuals. This is one of the highly popular and risk free investment opportunities for retail investors.
Let us discuss below why one should invest in recurring deposits and factors to be considered while opening the same.
All major banks across the country offer an option to open a recurring deposit account, with the term typically ranging between six months and 10 years, providing individuals an opportunity to choose a term as per their needs. As there is stiff competition among the banks to attract new customers, interest rates are competitive, helping investors to earn a good amount on maturity.
The salient feature is that interest rate, once determined, does not change during the tenure. On maturity, the investor will get a lumpsum amount which includes the regular, periodic investments and the interest earned upon the same.
Inculcate savings habit
As the saying goes, the first expense of a month is savings, and recurring deposits generally inculcate a regular habit of saving among the investors. Normally, the rate of interest offered is equal to that on fixed deposits. However, bankers generally do not allow premature and mid-term withdrawals. However, if the deposit holder insists, the bank may allow one to close the account before the maturity period, often with a penalty for premature withdrawal.
Serve as a collateral
Recurring deposit offers the additional benefit of taking loan against the deposit, i.e., by using the deposit as a collateral. One can avail up to 90% of the deposit value as loan. Investors, through standing instructions, can ask the bank to credit the recurring deposit account every month from their savings or current account.
Points to consider
Though recurring deposit is a safe investment option and the return on investment is mostly guaranteed, there are some factors that investors should consider before investing money in a recurring deposit account.
Check the interest rate offered
The interest rate offered by banks on different term periods varies from bank to bank owing to intense competition among them. The interest rate ranges from 3.5% to 8.5% per annum. The rate varies depending on the tenure of the deposit selected by the investor. For medium-term deposits, the rates are generally the highest. For long-term deposits, the rates are usually slightly lower as the deposit holder stands to gain a higher amount of interest overall.
Duration of recurring deposit
The term periods are broadly divided into three categories: A short-term tenure lasts from six months to a year, a medium-term tenure usually lasts from more than a year to five years and a long-term tenure lasts from more than five years to 10 years. Accordingly, one should invest in a recurring deposit account that provides a high rate of interest with the term period being as short as possible.
Option of premature withdrawal
Some times, bank provide the option of premature withdrawal on recurring deposits. In that case, the interest payable will be calculated based on how much of the tenure is completed. A premature withdrawal penalty might also be charged by the bank. Hence, while investing in a recurring deposit account, choose a bank which offers high rate of interest and charges a low penalty on premature withdrawal.
To conclude, while fixed deposits, another form of popular savings, are rigid in nature and not ideal for short duration, a recurring deposit could be an ideal investment and savings option for investors.
P Saravanan is a professor of finance and accounting, IIM Tiruchirappalli and S Aghila is a doctoral research scholar from IIT Madras, currently doing her internship at IIM Tiruchirappalli