The Advantages & Disadvantages of Fixed Deposits

For most small businesses, a bank account is simply a place to hold money. That's especially true for a checking account that's used for everyday transactions but pays virtually no interest. There is, however, a type of bank account that allows you to earn higher interest on your money in return for locking in your cash. Known as a fixed deposit, this investment option is worth considering if you have some cash that you do not need to use for at least 30 days.

How Does a Fixed Deposit Account Work?

A fixed deposit, also known as a time deposit or a certificate of deposit, works just like a regular bank account. The only difference is, you agree to leave a lump sum in the account for a fixed period. In the United States, that period can be anywhere from six months to several years. If you take your money out before the maturity date, then you have to pay a penalty known as an early withdrawal penalty. Hidden costs are virtually nonexistent, though, as the bank must disclose the penalty at the time of opening the account.

How Much Interest Does a Fixed Deposit Pay?

Interest rates vary quite a bit from bank-to-bank but generally, you can expect to get a higher rate than you would with a regular savings account. The interest rate is fixed until the maturity date so you can easily work out how much more interest your money would earn compared to, say, a regular savings account or an annuity. The longer you agree to lock down your money, the higher the interest rate you will receive. Larger deposits tend to receive better rates, too. For example, you may get a 1-percent rate compounded annually for a one-year fixed deposit of $10,000, or 2.5 percent if you deposit $100,000 for five years.

What Are the Advantages of Fixed Deposit Account?

There are advantages and disadvantages of a fixed deposit account, but primarily, a fixed deposit is a low-risk investment. All you're doing is putting money into a bank account that offers fixed and stable returns each month – there's no risk that you'll lose your capital as you might with a volatile stock investment. You can invest for a short or long period depending on your business's cash flow needs. As with any bank account, a fixed deposit is extremely liquid. You can close your account at any time after the initial lock-in period without penalty. At that point, the bank transfers the money back into your savings account together with all the interest it has earned. Alternatively, you can reinvest the money for another fixed period.

What Are the Risks of Term Deposits?

A fixed bank account comes with a lock-in period which can be anywhere from 30 days to several years, so it's not the best option if you're looking for a quick return. Since the bank will levy a penalty if you close the account prematurely, it's only suitable if you have surplus funds that you are not planning to reinvest in the business for some time. Be aware also, that you can make a deposit only once. If you have further cash to invest, you'll need to open a separate account. Another slight risk relates to interest rates. Since the rate is fixed until maturity, if the inflation rate goes higher than the interest rate, you could lose value on your investment.

How to Open a Fixed Deposit Investment at a Financial Institution

Most banks and credit unions offer fixed deposits so you should be able to walk into your nearest bank branch and open an account. Some banks will let you open a fixed deposit from the comfort of your own office, using your PC or a smartphone. You might need a minimum investment of, say, $1,000 or $10,000 for a term deposit to be opened – it depends on the bank. Terms and rates vary widely, so be sure to follow the usual advice and shop around.