Understanding fixed deposit and how it works

Over the years, we have successfully gone around the country educating individuals and engaging institutions on smart, safe, and wise investing. As part of our seminars, we usually go through the various investment assets and their commensurate level of risk and return.

The commonest among these assets is usually the Fixed Deposit. This investment asset is loved by several investors from our part of the world, but unfortunately many lack the proper understanding of it.

Today, we would like to discuss this investment asset called Fixed Deposit and how it generally works. A fixed deposit (FD), also known as a Certificate of Deposit, Term deposit or Time deposit, is a financial instrument offered by banks and other financial institutions except investment banks and asset/fund management firms. It is a type of investment where you deposit a specific amount of money for a predetermined period at a fixed interest rate.

In order to break it down for the investing public to understand and to know if it actually fits into their investment objectives, here are some of the key features of the Fixed Deposit instrument:

The Deposit Amount: First of all, you deposit a lump sum amount of money with the financial institution which is held for a fixed period. Usually, the bigger the investment amount, the higher the interest rate.

The Tenure: The second feature of a fixed deposit is tenure. The tenure or maturity period of a fixed deposit can vary, typically ranging between a few months, 91- days (3 months), 182 – days (6 months), and 365 - days (1 year). You cannot withdraw the funds before the maturity date without incurring penalties or losing your interest component.

This is one of the reasons you must be convinced this investment product is in line with your investment objectives.

The Interest Rate: The third key aspect of the fixed deposit is the Interest rate. The fixed deposit earns a fixed interest rate over the entire tenure. The interest rate is predetermined and agreed upon at the time of opening the fixed deposit account and depositing the agreed amount. It can be either simple or compound interest, depending on the terms and conditions set by the financial institution.

This is one important aspect of the fixed deposit that the investor must understand. Compound interest is the best option and if you can negotiate for monthly compounding, your investment can achieve rapid growth.

The Interest payment: The fourth one is the interest payment. The interest on fixed deposits can be paid at regular intervals, such as monthly, quarterly, or annually, or it can be paid upon maturity along with the principal amount. The interest payment frequency is determined at the time of opening the fixed deposit account and it must be clearly defined from the onset.

Safety: The fifth feature to discuss is the safety of the fixed deposit. Fixed deposits are considered relatively safe investments because they are offered by reputable financial institutions, and are usually insured up to a certain amount by government-backed deposit insurance schemes.

This protection is one of the reasons the interest offered by these financial institutions is lower than other fixed-income investment products. Of cause, fixed deposit product like every other investment still has some amount of risk. It is very important therefore that you consult your financial advisor before you take any investment decision because these issuing financial institutions have some risk just like any other institutions.

Liquidity: One key limiting feature of fixed deposits is Liquidity. While fixed deposits are considered relatively safe, they are not as liquid as some other forms of investments. Withdrawals before the maturity date may come with penalties, and the interest rate may be adjusted if the tenure is shortened.

This is done to discourage investors from withdrawing prematurely, but instead to leave their funds for the full tenure of the investment.

Form of Returns: The seventh feature is the form of returns from the investment. The returns from fixed deposits are predictable as the interest rate is fixed for the entire tenure. The interest earned is based on the principal amount and the interest rate agreed upon.

Fixed deposits are popular among conservative investors who prioritize capital preservation as their investment objective, and are looking for a relatively secure investment option. They are suitable for individuals who have surplus funds that they do not need immediate access to and are willing to commit their money for a specific period to earn a fixed return.

It is therefore very important to compare interest rates, terms, and conditions offered by different financial institutions before investing in a fixed deposit to ensure you get the best possible return on your investment.

Always remember that every investment asset has its own level of risk and therefore it is important to get compensated for the level of risk you take with your money.

For a deeper understanding of this subject and further assistance kindly contact EcoCapital Investment Management Ltd., at +233(0)50 155 3502.

EcoCapital Investment Management Limited (EIML) is a company incorporated in Ghana and licensed by the Securities and Exchange Commission (SEC) as an Investment Management firm, and by the National Pensions Regulatory Authority (NPRA) as Fund Manager of both second and third tiers of the national pension scheme.

The corporate mandate of the firm is to provide premium financial solutions and investment management services to both retail and institutional investors in Ghana. Services on offer at EcoCapital include Wealth Creation and Management, Investment Portfolio Management, Pension Fund Management, Mutual Funds, Retirement Planning, Investment Research and Advisory.

The firm has three mutual fund products under management, namely; EcoCapital Prime Fund, EcoCapital Nordea Income Growth Fund, and EcoCapital Weston Oil & Gas fund.

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