Today, fixed deposits are considered as most favoured investment avenue in India. Why do people prefer to invest in fixed deposit? Below are some of the key reasons

  • Safety of Principal with fixed rate of return
  • Good Liquidity to meet emergency needs as investments can be withdrawn anytime.
  • Any prior unsatisfactory experience by investing in equity or mutual funds.

Hence, people in India go for fixed deposit by compromising on returns because of their risk-averse frame of mind. With this headset people overlook to consider for what they are compromising on and the negative impact on their savings for long run. Undoubtedly, equity investments are the most recommended long term investment options for higher return. However, it’s not most righteous asset class for risk-averse investors who are willing to adapt growth expectations respectively. For such investors, there are better alternative investment options other than fixed deposit.

What are the drawbacks of parking money in fixed deposit? Let’s understand this with the help of some criteria and comparisons below.

Post-Tax Return

Fixed deposits on an average can fetch return around 8%-9%? When it comes to fixed deposit, people simply look for maturity value which can be predicted before investing and do not give much importance to post tax return. An illustration below will give better idea of post-tax return on FD.

If you invest Rs.10 lac in fixed deposit at an interest rate of 8%, your interest for the year would be Rs.80000 which is pre-tax return. Interest earned on FD is taxable as per your tax slab. Let’s say your tax slab is 30% which means tax that needs to be paid is Rs.24000. Hence, post-tax return on your FD is only 5.6% which is much lower than the expected.

Keeping this in mind, it’s better to invest in other investment avenues such as debt-oriented mutual funds, tax free bonds, Monthly income plans which are tax efficient. Interest incomes are tax-free. Long term investment in debt-oriented investments has the benefit of indexation. In this case long-term capital gains are taxed 10% without and 20% with indexation of cost. This saves the investor from tax burden.

Inflation-Adjusted Return

With the rise in price, post-tax rate of returns from FD is not beating the current rate of inflation.Let’s understand the effect of inflation with the same example.

Let’s say inflation rate is 6% and post tax return on FD is 5.6%. In this case, if you simply take a linear estimate by subtracting inflation rate(6%) from return (5.6%), you will arrive at inflation-adjusted return of -0.4%.

This means, your savings is deteriorating and you are not making any money for your long term goal. As an alternative if you invest in debt funds for a long term which is more than 3 years, you can enjoy the benefit of indexation to beat the inflation. Let’s go through an example to understand this.

Let’s say, you have held 10 lac in debt fund for 4 years (invested in 2011-12) which has given you return of 9% p.a. that means investment value will be 1411581 at the end of 4 years. Now your indexed cost would be cost of investment *CII in the year of sale/CII in the year of purchase = 1000000*1081/785= 1377070. Your gain for the tax purpose is 1411581-1377070=34511.(Please refer cost inflation index chart below).20 % tax on the gain would be around 6900. Post tax your investment value is 1411581-6900=1404681. This means your post tax return is approx 8.87%.

Risk of Reinvestment

To be on a safer side, people keep renewing their investment in FDs year on year without paying much attention to change in rate of interest. There is a downward trend in interest rates if we look at the past behaviour, and this scenario of falling interest rate is going to continue as RBI keeps the policy rates unchanged with the aim of price stability. You should understand this risk and make a smart financial decision keeping in mind the future financial goal.

Conclusion

To Sum it up, FD as an investment will not serve your purpose of saving money for future as there is almost no significant inflation adjusted post tax return. To break the popular perception of capital safety, only one lac of your FD savings is insured. FD’s are definitely not unsafe but there are alternatives like debt funds and tax free bonds who invest in good CRISIL rated securities which ensure capital safety along with inflation-beating returns as per their historical performance. With the changing time, you should also change your style of investment and consider investing a portion of your portfolio in equities for inflation adjusted tax efficient returns to serve your long term financial goals. Don’t just go by safety and block your money in FD; investing in proper mix of debt and equity based on your risk appetite is the smarter way of financial plan.

 

Reference:

Cost inflation index chart

Financial Year Cost Inflation Index (CII) Financial Year Cost Inflation Index (CII)
1981-82 100 1999-00 389
1982-83 109 2000-01 406
1983-84 116 2001-02 426
1984-85 125 2002-03 447
1985-86 133 2003-04 463
1986-87 140 2004-05 480
1987-88 150 2005-06 497
1988-89 161 2006-07 519
1989-90 172 2007-08 551
1990-91 182 2008-09 582
1991-92 199 2009-10 632
1992-93 223 2010-11 711
1993-94 244 2011-12 758
1994-95 259 2012-13 852
1995-96 281 2013-14 939
1996-97 305 2014-15 1024
1997-98 331 2015-16 1081
1998-99 351

Author: Rupanjali Mitra Basu

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