Key Differences Between Fixed Vs. Floating Rates

Do you want to maximize your returns while making the most of your savings? In the case of investments, one size actually does not fit all! You can instead choose between two options. Fixed interest rates (say, 8.40% throughout) are stable and predictable. Alternatively, you can opt for floating interest rate (varies), which can ride through the market waves. 

But now, which option is the one for you? Explore the differences between fixed vs. floating rates, so you can make informed decisions which align with your risk tolerance and long-term financial goals.

Quick Overview

• The fixed interest rate associated with an FD remains consistent throughout the tenure.
• The floating interest rate is a percentage that keeps varying as per the fluctuations of the market and general economic conditions. 
• While fixed interest rates guarantee stable returns, floating interest rates may yield higher returns but are associated with multiplied risk.

Fixed Vs. Floating Rates of Interest on Fixed Deposits

Fixed interest rates stay consistent throughout the established fixed deposit tenure. They guarantee stable returns. On the other hand, floating interest rates fluctuate on the basis of market conditions. They have the potential to offer comparatively higher returns when the rates rise. However, the risk factor is high too. 

The table below highlights the key differences between fixed versus floating interest rates: 

Fixed Vs. Floating Rates: Meaning

A floating interest rate means that the rate will vary based on fluctuations in the market. Usually, in a floating interest rate fixed deposit, the returns are linked to a reference rate. The Reserve Bank of India's repo rate and Treasury Bill yield are commonly used reference rates. 

The interest rate of a floating fixed deposit increases when the RBI repo rate increases. It helps investors earn a higher return to ensure a hedge against inflation. Notably, Yes Bank launched a floating rate FD in June, which is linked to RBI's repo rate. 

In contrast, fixed interest fixed deposits offer interest rates that are unaffected by market volatility. The interest rate applicable at the time of FD booking remains unchanged for the entire tenure. Banks and NBFCs offer various interest rates to depositors based on the investment amount and the tenure of the investment.

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Fixed and Floating Interest Rates: Advantages and Disadvantages

When investing, the choice between fixed and floating interest rates can significantly impact returns and risk exposure. Fixed rates offer stability and predictability, while floating rates may provide higher returns during favourable market conditions.

Let us first proceed with the advantages of fixed interest rate deposits before we dive any further into their comparison.

Advantages of Fixed Rate Deposits

The following are the pros of fixed rate fixed deposits based on fixed deposit rules and regulations:

1. Stable Returns: As the interest rates are fixed during the time of FD booking, the interest income is predictable. Thus, it offers a stable return on your deposits, making it suitable for short to medium-term investments. 
2. Low Risk and No Market Dependency: As fixed rate fixed deposits are not linked to the market, low risks are associated with this investment. This makes it a secured investment for conservative (risk-averse) investors. 
3. Capital Protection: Fixed rate fixed deposits ensure capital preservation. Investors receive the principal and the accrued interest on maturity or during the desired payout option selected at the time of booking.
4. Flexible Tenure: Fixed rate fixed deposits allow investors to choose a tenure of booking based on their financial goals. As an investor, you can select a tenure ranging between 7 days to 10 years.
5. Fixed Regular Income: You can receive regular interest income if you choose monthly, quarterly or annual interest payout options on a fixed rate fixed deposit. The interest rate remains unchanged, enabling you to plan your finances in advance. 

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Disadvantages of Fixed Rate Deposits

Here are the cons of fixed rate fixed deposits:

1. Taxable Interest: The interest income on fixed rate fixed deposits is subject to taxes at the investor’s tax slab rate. This lowers your overall returns, especially if you fall under a high tax slab. Banks and NBFCs also deduct a 10% TDS (tax deductible at source) on the interest if it exceeds ₹40,000 for non-senior citizens and ₹50,000 for senior citizens during a financial year. 
2. Interest Rate Can Be Lower Than Inflation: Fixed rate fixed deposits often offer lower returns compared to several asset classes. As a result, investors often face challenges beating the inflation rate with fixed rate fixed deposit interest income. The real value of returns from such a fixed deposit decreases over time. 
3. No Increase in Interest Rates: As fixed rate fixed deposits offer a constant interest rate determined at the time of booking, investors cannot earn a higher interest rate with an improvement in market conditions. Thus, as an investor, you can grow your wealth by a specific amount.

In general, fixed rate deposits offer stable returns with capital protection and flexible tenure, but may yield lower post-tax and inflation-adjusted returns, with no benefit from rising interest rates. 

Let us now compare it with the advantages and disadvantages of floating rate deposits. 

Advantages of Floating Rate Deposits

Here are the main benefits of investing in floating rate deposits:

1. Hedge Against Inflation: Floating rate fixed deposits provide a hedge against inflationary trends. As the market interest rates rise with inflation, investors can reap the benefits of high interest income from floating rate fixed deposits. 
2. Market-linked Returns on Investment: Investors can enjoy market-linked returns on their FD investment from floating rate fixed deposits. However, they do not need to directly invest in equities or riskier assets to enjoy the returns. 
3. Rate Hike Benefits: When banks offer higher rates on fixed deposits, investors can reap the benefits of higher returns. The increased floating interest rates are likely to exceed conventional fixed deposit rates for a given tenure. 
4. Interest Rate Diversification: As an investor, you can diversify your investment portfolio with floating rate fixed deposits. It helps diversify the risk pertaining to interest rate fluctuations. 

Disadvantages of Floating Rate Deposits

Floating rate deposits carry some disadvantages, including:

1. Uncertainty: As floating interest rates of fixed deposits vary based on reference rates, it imposes uncertainty in financial planning. Investors often face challenges calculating the interest payout for a tenure. 
2. Risk of Rate Decrease: If the bank's floating rate decreases due to fluctuations in the repo rate, investors will earn a lower interest income. As a result, risks of market condition changes are associated with floating rate fixed deposits. 
3. Difficult to Compare: Investors often face difficulties comparing floating interest rates of fixed deposits of various banks and NBFCs. This is due to the dependence of the interest rate on reference rate changes. 

Fixed Interest Rate and Floating Interest Rate: Which One to Choose and When?

Floating rate fixed deposits offer variable rates for investors able to bear market risks. On the flip side, fixed rate fixed deposits offer a predetermined interest rate for a given tenure. As a result, if you are a conservative investor, it is advisable to choose a fixed rate fixed deposit. However, if you can tolerate slight risks, you can choose a floating rate fixed deposit. 

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