Is your fixed deposit earning you any return? - Views on News from Equitymaster

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Is your fixed deposit earning you any return?

Jul 11, 2013

As an investor you invest to earn a certain rate of return. In the volatile world that we live in today, these returns are getting more and more hard pressed. Stocks are getting battered. Gold has been falling too. This has led many to park their funds in fixed deposits. With interest rates hovering at high levels, most individuals who took this option were happy with their choice. Even though the Reserve Bank of India has brought interest rates down, the returns being offered by the fixed deposits continue to be attractive. At least this is what most people think. However the truth is far from this.

The reason for this is the concept of real interest rates. In simple words, real interest rate is the interest rate being offered by the bank less the prevailing inflation rate. As individuals, the inflation that affects us is the consumer price inflation. Therefore, this is the one we ought to look at when we are looking at the real interest rates on our investments.

The chart below shows that the rate of interest being offered on fixed deposits has not even covered consumer inflation. And this is considering the higher end of interest rates being paid on fixed deposits by the banks.

Source: Reserve Bank of India
* Interest rates on fixed deposits with more than 1 year of maturity

This makes you wonder whether keeping all your money in fixed deposits is really worth it. After all, the returns generated here hardly even cover the increased cost of living that you suffer on account of higher inflation.

So should you completely avoid fixed deposits?

Though fixed deposits do not offer returns that cover inflation, but they are still a relatively safer form of investment. Therefore, giving them a complete miss would not be a prudent idea. The thing is we believe keeping aside some safe cash as absolutely necessary. Not only will this cash take care of your liquidity needs, but it will also come handy during market declines. Particularly when there will be opportunities to pick up fundamentally strong stocks at cheap valuations. And fixed deposits as such present a good avenue for parking this safe cash. After all, these deposits still offer better rates when compared to a simple savings bank account.

In today's scenario, you may be tempted to put your safe cash in the higher interest rate fixed deposit schemes being offered by some corporate houses. That in our opinion would be a disastrous mistake. You see despite the fact that bank FDs may offer returns that may not cover consumer inflation; they are still a relatively safer place to keep your cash in. For the chances of banks defaulting in returning your deposit are almost negligible as compared to the corporate.

Last but not the least, we cannot emphasize enough that you should be careful about your overall asset allocation.

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1 Responses to "Is your fixed deposit earning you any return?"

Savio

Jul 12, 2013

That was too simplistic an article. There are other instruments that you can park your money in, such as debt funds (where the actual returns might not be completely certain but where you generally do not lose money). Debt funds offer a favorable tax treatment. In addition, FDs have a premature withdrawal penalty. Depending on the debt fund you choose and the tenure, there may be no penalty at all.

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