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Are fixed deposits really a foolproof way to invest?

Jul-21-2022


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Are fixed deposits really a foolproof way to invest?

Large banks' fixed deposits are among the safest investing options. For years, this has been the go-to financial investment for many Indian savers. Fixed deposits are regarded as the safest and most liquid investment available. Let us try to learn which financial investments are actually safe through this blog.

What is the purpose of investing?

An investor saves money today in order to accomplish a financial goal/objective in the future. Life objectives can include purchasing a home, educating children, marrying children, and eventually living a financially independent life during retirement.

To achieve financial objectives, two important variables must be generated.

1.       Save enough money

2.       Produce adequate returns on savings

The point to remember here is that saving alone is rarely enough to attain long-term goals, especially those that span decades. As a result, creating returns on savings becomes critical in reaching long-term goals such as retirement.

What exactly are adequate returns?

Individual definitions of adequate returns differ, but the commonly accepted meaning is earning more than the inflation rate. Inflation is the rate at which the value of your money erodes, therefore earning returns greater than inflation protects the value of your money over time while also delivering real returns above inflation. This is especially true for long-term financial goals with significant value degradation due to inflation.

The effect of taxes on returns

Taxes, like inflation, depreciate the value of your investment. Returns must be calculated after any applicable taxes have been deducted. As a result, ideally, after-tax profits should be greater than the ongoing inflation rate.

Let's look at after-Tax FD returns over the last 5 years.

 

Mar 2018

Mar 2019

Mar 2020

Mar 2021

Mar 2022

FD returns (%)[1]^

6.60%

6.80%

5.90%

5.10%

5.10%

FD returns (after tax, %)*[2]

4.62%

4.76%

4.13%

3.57%

3.57%

Inflation rate (%)#[3]

4.28%

2.86%

5.84%

5.52%

6.95%

Real returns (%)

0.34%

1.90%

-1.71%

-1.95%

-3.38%

[1] SBI FD rates

[2] Assuming a 30% tax rate

[3] YoY inflation rate assuming March as base

From the above chart, it's evident that real returns on FD have been either meagre or negative during the last five years.

So, are fixed deposits foolproof ways to reach your financial objectives?

Fixed deposits are excellent choices for accomplishing short-term objectives. Because the returns are fixed and somewhat liquid. Fixed deposits, on the other hand, do not routinely generate returns (after tax) that outperform the inflation rate.

As a result, investors who use Fixed Deposits to attain long-term financial goals are jeopardizing their capacity to achieve those goals. The real risk of investing is not the short-term volatility of returns, but the long-term ability to attain financial objectives. Therefore, fixed deposits from this perspective are not really safe for long-term investors.

 

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