While FDs offer guaranteed returns, these returns are typically modest. In an era of rising living costs, the purchasing power of your money can diminish, leaving you with less than you started with in real terms.
Inflation: The silent wealth killer
One of the biggest drawbacks of fixed deposits is their vulnerability to inflation. When the interest rate on your FD is lower than the inflation rate, your real returns are negative. This means that while your nominal money grows, its actual value decreases. Over time, inflation erodes your savings, making fixed deposits a poor choice for wealth accumulation.
Shlok Srivastav, Co-founder and COO, Appreciate, says “Consider the fact that FDs by taking away the bite of volatility and market risks also stun your wealth growth. Over a shorter time frame, say a year or two, your FD might manage to deliver better returns than a diversified equity portfolio, especially if the market is going through a bearish spell. However, equity returns more than compensate for the lost ground in the long run. Well-performing mutual funds give returns in the 12-15% CAGR range, miles ahead of FD returns. The returns from equities also tend to compound at a faster rate in the long term compared to FDs.”
Alternative opportunities
By investing all your money into fixed deposits, you miss out on potentially higher returns from other investment avenues. Stocks, mutual funds, and real estate, though riskier, have historically provided significantly higher returns than FDs. Diversifying your investment portfolio can lead to better long-term growth, helping you build wealth more effectively.
“A 10-year investment of ₹1 lakh in a bank FD, which gives 6.5% returns today, will grow to ₹1.87 lakh, assuming annual compounding. On the other hand, the Nifty index has compounded at the rate of 12% in the same period. That means, the same investment in Nifty would have grown to ₹3.11 lakh in 10 years. This shows how more efficient products such as stocks, equity mutual funds or index funds that mimic Nifty can create wealth for an investor,” says Shrinivas Khanolkar, Head – Products, Marketing & Corporate Communications, Mirae Asset Investment Managers.
Echoing similar sentiments, Trivesh D, COO of Tradejini says “By exclusively investing in FDs, the opportunity cost lost is very high. One misses out on the potential for higher returns offered by listed stocks and bonds which have provided returns in the range of 12% – 15%. Historically, the stock market has outperformed FDs, particularly over the long term, where the effect of marginal compounding significantly enhances wealth accumulation. Even an incremental difference of 1.5 to 2% annually can result in a substantial disparity in the total returns, potentially leading to a difference of over 50% in returns over a decade.”
Tax implications
Interest earned from fixed deposits is fully taxable, which further reduces the net returns. Depending on your tax bracket, a significant portion of your FD interest can be eaten up by taxes. Tax-efficient investment options, like certain mutual funds or retirement accounts, can offer better post-tax returns.
“FDs have less flexibility, as early withdrawals typically incur penalties. If you are Investing 1 lakh in 5 year FD with 7% annual rate it grows to ₹1,40,255. However, after accounting for taxes (up to 30%) and adjusting for inflation (approx 5%) , the real gains are significantly reduced, making it a less attractive investment option,” says Palka Arora Chopra, Director of Master Capital Services.
Key lies in diversification
In today’s dynamic financial landscape, adaptability is key. Fixed deposits represent a static investment approach, which may not keep pace with economic changes and evolving market conditions. By exploring a mix of investments, you can ensure your money works harder for you, adapting to shifts in the economy and your personal financial goals.
So, one would wonder what is the alternative. Most wealth experts suggest that the solution does not lie in refraining from fixed deposits or investing in them in entirety. It lies in the middle. Yes – it’s good to diversify.
Viram Shah, CEO, Vested, says “FD investors who are used to fixed income like products but want a better return on their investment, at the cost of slightly more risk, can invest in corporate bonds where SEBI has recently allowed investment as low as ₹10,000. Further post tax, fixed deposits barely give 4-4.5% returns which are even lower than inflation in India.”
Financial experts always recommend diversification to spread risk. So, investors should remember that relying solely on fixed deposits exposes you to interest rate risk and ignores the benefits of a well-rounded investment portfolio. By diversifying, you can balance risk and reward, maximising your financial growth potential.
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Published: 24 May 2024, 09:23 AM IST