Are FDs the only way to invest your savings?
Many Indian often show a penchant for investing in Fixed Deposits (FDs), as they are perceived to be safe. But should safety alone be criteria to invest a dominant portion of your hard earned money in FDs? With the inflation bug once again creeping and disturbing the moderation which was evident until sometime ago, have you thought about guarding the purchasing power of your hard earned money?
You see, we strive hard all our life to earn money so that we can fulfil our dreams and that of our family. And in order to fulfil these dreams, we often invest the money we save. But the question is are you effectively and prudently investing so as to counter the inflation bug. It is noteworthy that inflationary pressure persisting in an economy has an impact of eroding purchasing power of your money, and thus it becomes imperative for you to make productive investments. Mind you, we aren't defying investing in FDs, as they to earn you returns through the rate of interest they offer. But it is vital to recognise that you may not be able to meet your financial goals. Let's see why...
Let's say you are investing in a fixed deposit offering interest at the rate of 9.00% p.a. in a scenario where the average inflation rate is say 8.00% p.a. In such a case of you haven't yielded a very fruitful return which can counter inflation since you are effectively earning only 1.00% (pre-tax) as the real rate of return. And since interest on FDs is taxable as per the marginal rate of taxation, the real rate of return lowers further.
You see success in investing emanates when you end up clocking a wider real rate of return which is calculated as:
Real Rate of Return = Nominal rate earned on the instrument - Inflation Rate
PersonalFN believes that instead of focusing only on nominal rate of return, i.e. interest rates offered by banks or the gross returns; one should always concentrate on tax-adjusted real rate of returns.
Investments need to be made prudently so as to yield fruitful returns for you, or else your dreams (such as buying a dream home, a car, providing the best education to your children, getting them married well, or even planning for your retirement) could be farfetched and not turn into reality.
Your investment portfolio should be structured on the basis of your risk profile, which can facilitate it to be aggressive, moderate and conservative in various time frames as your age progresses, financial conditions and nearness to financial goals amongst host of others. You must have a mix of various asset classes - equity, debt and gold; so as to diversify well and enable an opportunity to counter the inflation bug better, thereby guarding the purchasing power of your hard earned money.
While investing in FDs is perceived to be safe, you must always check the credit profile - especially if you are contemplating investing in corporate FDs. Also do not ignore the other aspects such as the real rate of return of you would fetch and the post-tax yield, or else may end up eroding the purchasing power of your money. Only if one is extremely conservative (as guided by your very low risk profile) and / or has a short-term investment horizon, investing in FDs may be considered by studying facets such as tenure, interest pay-out options and premature withdrawal clause.
Ways to counter inflation...
If your risk profile and investment horizon permits, you should ideally have some exposure to equities. Equity investing offers an opportunity to earn high returns, but comes with high risk. Also it offers high liquidity and enjoys a favourable tax status as well. Research reveals that over the long-term equities as an asset class has delivered far superior returns as against those clocked by debt instruments such as FDs. Thus on the real rate of returns (which adjusts inflation) basis as well, equity investments have fared far better and guarded the purchasing power of your money. The favourable tax status enjoyed by equities wherein it's exempt from Long Term Capital Gains Tax has facilitated equities over the long-term generate better real rate of return. Over the short-term while you may encounter volatility and at times even resulting in losses, over the long-term the asset class tends to perform better and earns you dividend income and capital appreciation. If you are well-versed about investing in equities, you could invest directly in stocks, but if you naïve or do not have sufficient time and resources to facilitate effective stock picking, then the mutual fund route may be appropriate for you. But while investing in mutual fund schemes, care should be taken to select the ones are consistent performers and are from fund houses which strong investment processes and systems.
Today with ascending trend shown by real estate prices, investing in property can also be considered. The only deterrent here is that the minimum amount you need to invest here is substantial and beyond the reach of most investors. Though it involves high cost and low liquidity, it offers you an opportunity to earn a second income in the form of rent. The past trend in prices suggest that investment in real estate or property has been quite rewarding, and can be considered by one as an 'alternative investment' in your overall investment portfolio. However, while you invest in property, you ought to adopt caution and look into the following aspects amongst others:
It is noteworthy that India offers a huge growth potential in the infrastructure space, and thus given that if one lets out the property on rent, appealing rental yields could also obtained, apart from capital appreciation over a period of time. However while you approach this asset class, care should be taken to ensure you aren't accounting the house you live in (also known as the primary home) as an investment, since it primarily for your own dwelling and has an emotional value imbibed in it.
- Who is the builder?
- What has been his track record?
- Has he completed the construction of his projects as per schedule?
- Visit the site and inspect the quality of construction
- The rate which he is offering for the amenities offered
- What would be the approximate maintenance cost?
- The development in the surrounding area where you intend to invest
- Title of the property on which the construction is or has taken place (to ensure that it free from any encumbrances and litigation)
- Has he obtained all statutory permissions
- In case of a ready property - i.e. newly constructed or a resale property, has a society being formed
- Is the builder listed or recognised by the housing finance company (in case if you want to avail a home loan facility)
Investing in gold can also help you preserve the value of money as it is considered a good hedge against inflation. During times when economic uncertainty prevails, gold tends to be store of value and usually tends to get appreciate. Over the long-term this asset class has also delivered luring real rate of returns, but unlike equities, long term capital gains are taxable. It is noteworthy that gold generally tends to perform inversely vis-à-vis equities in times of risk-on and risk-offs. While investing in gold you can either buy physical gold or invest in Gold Exchange Traded Funds (GETFs) or gold savings funds. But we recommend that you invest in the precious yellow metal the smart way and that is through GETFs for the host of advantages it has to offer. Alternatively, gold savings funds (which invest in GETFs) can also be considered if you want to invest regularly in gold, as such funds offer you the Systematic Investment Plan (SIP) mode of investing> , which provide you with the benefit of rupee-cost averaging and compounding.
Recently the Reserve Bank of India (RBI) also launched Consumer Price Index (CPI) inflation linked bonds, for investors to hedge the risk of inflation and preclude the dependence on gold to so (as investors flock to gold during inflationary and uncertain times). But absence of favourable tax status makes investing in them rather a deterrent, especially in the backdrop of several tax-free bond issues available for subscription. PersonalFN believes while CPI inflation linked bonds are a relatively better option to investing in FDs, they aren't very appropriate for planning for long-term financial goals, because the overall returns from the instrument would come under pressure during times of easing inflation.
So, it is important to have exposure to a mix of asset classes in the portfolio and investment instruments therein, so as to clock better post-tax real rate of return on your portfolio. However care should be taken to follow the right asset allocation suiting your risk profile and diversify your portfolio well intra-asset class too thereby facilitating your savings to grow manifold.
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
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