What you need to know:
While there other investment opportunities with higher returns, fixed deposits are favourable for those who are averse to risk.
If you want your money to grow while earning some interest, rather than leaving it in a regular bank account, a fixed deposit account can be a good option.
Fixed deposits can help you develop a strong savings culture considering that you are unable to withdraw the money until the agreed upon duration with your bank expires. While there other investment opportunities with higher returns, fixed deposits are favourable for those who are averse to risk.
Mr Daniel Babonereirwe, a banking consultant, describes loans as assets of a bank and deposits as liabilities. So, banks are intermediaries who get from surplus spending units and lend to the deficit spending units of the economy.
“To fix money, you remove it from a current account, let us say from a savings account and fix it for a period, meaning in that period, you are not going to utilise that money or withdraw it,” Mr Babonereirwe says.
On the other hand, that money is so certain and the bank needs that certainty to know that it still has your money for say six months, or one year.
But if the bank has that money on a current account it is not so definite. If you have Shs1 billion on the current account, you are not sure as to when it will be withdrawn.
Fixed deposits are similar to savings accounts, only that you cannot access your money for an agreed fixed period like one, three, six months or one year and the longer the money stays in this account, the higher the interest earned.
He notes that if it is on a fixed deposit account, you cannot just walk in the bank and demand for it immediately. There are terms. The idea of fixing is fixing time, it is the same calculation, the principle amount, the rate and time.
He says that if there are three forms of accounts, savings, current and fixed deposit why would one choose a fixed deposit?
In economics, there are four reasons for holding money. We have the speculative motive, precautionary motive, investment motive and probably the spending motive.
Other than that, Mr Babonereirwe says the money you want to spend every time should be held onto a current account. However, if there is money you are speculating for a deal, put that on a savings account. Then the money you are accumulating for investment should be put on a savings or fixed deposit account.
The money for precautionary purposes might as well go to a fixed deposit account, or savings. What if you fall sick and need money! But you are not going to need it and you are not sure of when you will need it. If the eventuality does not happen, it still earns you money.
He questions that if it is a bond, could you break it immediately? A savings account is more flexible than a fixed deposit account. Anytime you can walk in and withdraw it without prior arrangements.
For a fixed deposit account, you cannot get your money without a request to your bank in writing on why you want to break it.
He says a fixed deposit account helps in investment since it is a liquid asset which is earning.
If I have a house that you want to buy and it needs a lump sum, you are not going to keep that lump sum on a current account, where you are charged for keeping money there. You would rather earn that 11 per cent, than having this money reduced every month, through ledger fees without withdrawing it.
How a fixed deposit account earns you money
For this Mr Babonereirwe says banks get money from depositors, and lend it to borrowers, that is how you earn money. The bank keeps trading with your money, so the bank may be giving you 11 per cent interest, but actually lending it at 18 per cent or 24 per cent.
However, he mentions that if your motive is speculative, your likelihood of breaking it is high, that is where you negotiate a bit. You may agree to change the rate, but with the flexibility of drawing half way, without losing all the interest. You could lose a percentage of that interest but not the whole of it.
Different banks have different flexibilities around it. There is what they call a window account, where fixed deposits also have different types.
Mr Babonereirwe says the window account in a fixed deposit is used regularly for the salary earner, one can say he or she will be adding one third of their salary every month. They keep accumulating on that fixed deposit.
He says for the banks that is easily allowed, and the beauty about it is the owner of that account, on the other side is that should one need some money, they can withdraw up to a third without losing their interest. That is from bank to bank and from client negotiation depending on how the client agrees with their bank.
He further states that the variable for negotiation on fixed deposit account interest, your ability to negotiate, is inversely proportional to the amount and length of time you are keeping the money. If you are keeping it for a long period, it is much easier to negotiate.
For example, “If you are keeping huge sums of money, let us say Shs1 billion, the more power you have to negotiate. If you are saving like Shs300,000 chances are you have to go with the rates the bank gives you.”
Fixed deposit during retirement
Mr Babonereirwe says a fixed deposit account is also a good way of making passive income as you work and near retirement. At such a time when you no longer have that energy, you can put your money in a fixed deposit account. So instead of working for money, your money now works for you.
He asserts that here, you can get your NSSF savings, put it them in the bank and agree on monthly withdrawals of just your interest, so that you do not touch the principle.
You may agree with the bank that your interest is put on your savings or current account, so that you do not have to seek permission to withdraw it.
But, he says, if you earn interest from the fixed deposit account, the government taxes you on that interest. You can calculate all that in advance to know the actual amount you will get.