Bank FD interest rates touch 9%; which fixed deposit tenure will get you best returns: 1,2,3 or 5 years?

Rising interest rates in the last year have made fixed deposits (FDs) attractive. Just a year ago State Bank of India (SBI) was offering the highest rate of only 5.5 per cent on FDs, now it offers an interest rate of up to 7.10 per cent. Several private sector lenders, including HDFC Bank and ICICI Bank give interest rates of up to 7.1 per cent on FDs. You can get an interest of up to 7.2 per cent on fixed deposits in Kotak Mahindra Bank. Senior citizens can even earn an additional interest rate of 0.50 per on fixed deposits. YES Bank offers a whopping 8 per cent interest rate to senior citizens. Meanwhile, fixed deposit interest rates have touched a lucrative 9 per cent in small finance banks. While the possibility of a further rate hike cannot be ruled out, however, interest rates may have reached very close to the peak of the current cycle.

Do remember that the rise in interest rates has not been uniform across tenures. As you know, interest rates of fixed deposits vary depending on tenure. Short-term or long-term — which should be the ideal tenure to book to get the maximum return on fixed deposits? Let's find out.

Rising FD interest rates
Since May 2022, the Reserve Bank of India (RBI) has hiked the repo rate by 250 basis points. To meet the growing credit demand as liquidity tightens, banks have also increased the interest rates of fixed deposits, but at a slower pace. Moreover, the transmission of deposit rates is not the same across all the fixed deposit tenures. For instance, the leading public sector banks have raised interest rates for short-term deposits (up to three years) by 170-180 basis points while interest rates of long-term deposits (three to five years) have only gone up by 100-110 basis points, said Anand Dalmia, Co-founder & CBO of Fisdom.

Don’t put all your money into one big FD
In this scenario, should you put all your hard money into one large deposit which offers the highest interest rate? It can be a better idea to avoid investing all your money in a single fixed deposit, even if it is giving you the highest return in the market, said many experts. Now, let's understand how to select a tenure for your fixed deposit to get the highest return.

Also Read: 9.25% interest on 700 days FD, 7.2% on 390 days FD: How to select special bank fixed deposit for best return

How to choose your FD tenure to get highest return
You need to select your FD tenure based on your investment horizon and the prevailing interest rates, said Naveen Kukreja - CEO & Co-founder, of Paisabazaar.com. At present, the highest interest rate on fixed deposits offered by most banks is between one year and three years, he added. So, choose the tenure based on your need. For instance, if you want the funds after three years and the bank is offering a higher interest rate on a one-year or two-year FD, you can book a one-year FD now and reinvest the money after a year. However, do not opt for the auto-renewal option as it won’t give you a chance to compare the interest rates banks are offering at the time of maturity and invest accordingly. There may be a possibility that by tweaking the tenure at the time of reinvestment you may get a better return.

Want maximum return from your fixed deposit? Try laddering
If you do not have a particular need and are investing money to grow wealth, then you might consider the laddering approach which recommends dividing your investment amount into several parts.

"Given this situation, we suggest that investors stagger any fresh investments in fixed deposits if they want to lock in higher rates," said Dalmia.

However, you should avoid parking all your money in fixed deposits of a single tenure to mitigate reinvestment risk, said Vishal Dhawan, a CFP and founder of Plan Ahead Wealth Advisors. If you invest all your money in deposits of similar tenures, then all your FDs will mature at the same time. If that maturity coincides with a low-interest rate cycle, then you might have to reinvest all your money into low-interest rate options when the deposits mature, Dhawan said.

"Laddering deposits is a way to stagger your investment into multiple accounts of varying intervals to earn high returns with regular liquidity," said Adhil Shetty, CEO, Bankbazaar.com. Let us understand what an FD ladder is. Instead of booking one big FD for a long tenure, you have to divide it into various parts in a particular order.

Also Read: Fixed Deposit: How much senior citizens can invest in FD every year to get tax-free return

How to create an FD ladder for the best return
The difference between the highest FD rates of banks and their five-year FD rate is lower in bigger private banks. "The highest FD slab rates offered by PSU banks are about 50-100 basis points higher than the rates offered on their five-year fixed deposit tenure. In the case of small finance banks and most private sector banks, the differences between their highest FD slab rates and their five-year FD rates mostly range between 50 and 150 basis points. However, major private sectors banks like Axis Bank, ICICI Bank, and HDFC are exceptions as the rate differences in their case are just 10-20 basis points," said Kukreja.

For laddering, you may have to invest across different tenures. This means for the medium tenure of two-to-three years you may get better deals in PSU banks while for long-term FDs with a tenure of five years or above bigger private banks may be a better option especially when you wish to avoid small finance banks.

Investors may consider allocating 50 per cent FD to a short-term fixed deposit, considering the current scenario, Dalmia said. The residual can be spread through tenures between one and three years, Dalmia added.

"Depending on the liquidity-timeline requirements, one can look at creating a ladder of fixed deposit with varying tenures. If looking to park funds in FDs for very long, then a major chunk can be locked in now as well in the longer tenure FDs. The rest can be gradually booked over the next year or so. Such FD laddering not only gives a chance to earn better returns in the rising rate environment but also better manage liquidity requirements," said Dev Ashish, a SEBI Registered Investment Advisor and founder of StableInvestor.com.

Such a laddering strategy in FDs offers investors the opportunity to capitalise on relatively higher rates offered currently while also capitalising on potential upside.

Will FD interest rates increase further?
The Reserve Bank of India kept the policy repo rate unchanged at 6.5 per cent in its bi-monthly monetary policy meeting held in April. Addressing a press conference after making his statement on the monetary policy, RBI governor Shaktikanta Das said, "It’s a pause and not a pivot."

"In fact, five-year FDs are currently giving lower interest rates as compared to what two-three-year FDs are giving. This is a factor of the asset-liability mismatch in terms of tenure, which needs to be corrected," Suresh Sadagopan, an RIA and founder of Ladder7 Financial Advisors.

"Though low probability, another round of policy rate hike is not completely off the table," said Dalmia. "Considering these dynamics, one could conclude that the rates of five-year FDs are indeed close to the peak, but there is still room for some upside," he added. Echoing the same sentiment, Sadagopan said, "We are already near the top of the interest rate cycle. Having said that, the interest rates could go up somewhat from here."