Fixed Deposits or their close cousin RD’s (Recurring deposits) are the most popular saving instrument in India. According to RBI, Indians invested approximately Rs 6800 Billion in fixed or bank deposits that means more than 55 % household savings are invested in Bank deposits.
While Fixed deposits or FDs are popular because of the risk-free nature of this asset and relative ease of investing and managing. However, if you have huge expectations from your FD investing strategy, they might not prove to be the best investment instruments to grow your money.
Fixed Deposits: Important points to consider
1. Post-tax Returns very less on Fixed Deposits:
Next time you hear that an FD has got a return of 8%. You need to take it with a pinch of salt. Fixed deposits attract TDS so the actual return after tax will be much lesser than the sticker return.
You can calculate post-tax returns in a simple way see one example below.
Example:
Say, you have an FD of Rs. 10000 at 8% interest p.a. Now, does that mean you will get Rs. 800 interest? No, you will actually get a lesser amount. With a tax rate of 30 % , you will only get Rs 560 , that means an annual return of 5.6 % only.
Simple formula to calculate this is :
Post-tax returns = Pre-Tax returns * { (100-Tax Rate) / 100 }
Ok, lets put things in perspective, if you include tax into calculations your FD return will be reduced by your tax rate so, for people in 30 % bracket, it will be reduced by the same.
Below table explains how your post-tax return will look like on your FD Rate:
| Tax slab | Post Tax Returns * |
| Below Taxable Income | 8% |
| 10 % Tax Slab | 7.20% |
| 20 % Tax Slab | 6.40% |
| 30 % Slab | 5.60% |
*Please note that we have rounded off Tax rates so returns shown might vary from actual returns.
2. Inflation adjusted Returns may erode your income:
After taxes, what can hurt any investor is inflation. Before we explain how, let’s look at the average CPI-based inflation in India in the past few years.
Source: RBI data
If you look at the table above Consumer inflation in India has been hovering around 6% . So any asset class whose post tax return is 6 % or less, is actually reducing your wealth.
Inflation adjusted rate ( Real Interest rate) = Nominal Interest Rate – Rate of Inflation
Taking the same example above:
If your FD is giving a return of 8% and you are in the 30 % tax bracket. Your post-tax return is 5.6 % only. Now, if inflation is 6 %, then your wealth or savings are going to erode approximately at the rate of 0.4 % per annum. In short with inflation hovering around 5.5- 6% most of the FDs shall give negative rate of return.
3. Liquidity comes at a cost:
Fixed deposits are supposed to be liquid means. You can withdraw money at any time at a short notice. But, most of the time this liquidity comes at a cost. Most big banks charge a penalty of 0.5-1 % for premature withdrawal. One tip to overcome this is to create multiple small FDs rather than one single FD.
4. Tax is always deducted at source:
One more crucial point to note with FD investment is that tax deduction happens at source unlike some debt mutual funds, where you can defer taxes. Hence, your capital can grow much faster through other long term investment alternatives.
Let us explain this in detail:
Taking the example we used in point 2, if you have an FD for Rs.10,000 and your interest rate is 8% p.a. You earned Rs. 800 as interest, now post deduction your interest is Rs 560 only. Hence, your new principal is Rs.10560. As a result, you have a lower base to grow. In case of debt mutual funds, you can keep on deferring tax till you withdraw and hence your money can grow at a faster pace.
5. You can easily beat returns with almost not additional risk:
You can easily replace your FD portfolio by investing in short-term debt instruments and liquid funds, to get additional 1-2 % of returns. Liquid funds invest in short-term securities with maturities less than 91 days. Depending on the fund investments can be in government securities or short-term corporate bonds. Short term debt funds also invest in mix of g-secs and SCB’s but with a maturity of 91-180 days.
Fixed Deposits Investments: A Final Take
While Fixed Deposits have been a traditional and a very popular saving instrument for individual investors in India. FDs are still regarded as the safest investment option for risk averse investors. So, if you are satisfied with fixed returns without taking any risk, investing in FD might be a good fit for you.
But, if you wish to expand your risk horizon and look beyond FD investing, you can get to explore a whole lot of investment alternatives to diversify your portfolio.
You may also like to learn: How to calculate interest on FD?
So, how do you invest your money? Do you prefer fixed income instruments like Fixed deposits or you look forward to trying other emerging investment options also? Feel free to share your feedback and experiences thereon.