Investments in fixed deposits of banks are widely considered as the wise and the safest option to park your money. Particularly, the nationalized banks. The supporting reasons include easy liquidity, sovereign guarantee, easy availability of loans on pledging the FD receipts, etc.
However, do you really earn the 9% or whatever interest offered by the banks? If you haven’t yet thought about it or don’t know about it, it is high time to think and act. Because you are gradually losing your hard-earned savings, rupee by rupee! But how? Let’s see how:
Risk
The term deposits with nationalized banks are considered safe. This is because of the notion that the government may come to the rescue of depositors if the bank fails. However, the fact is actually different.
According to the RBI guide, deposits including principal and interest of only up to Rs 1 lakh have insurance with the Deposit Insurance And Credit Guarantee Corporation. “Deposits” here mean all the deposits you have made with a bank viz., savings, fixed, recurring, etc. In case of failure of a bank, any amount you have deposited beyond this threshold has no guarantee. Whether it is a private bank or a nationalized bank doesn’t matter. You may have to scatter your deposits between different banks if you really need to mitigate this risk! However, so far we have seen the RBI and the government coming to the rescue of depositors when a private bank or a nationalized bank fails.
Interest
The interest rates offered by nationalized banks on fixed deposits in 2013 averaged around 9% annually, compounded quarterly, for deposit tenures ranging from 1 to 2 years. The maximum interest rate offered was for a period of 1 to 2 years. For other tenures less or more than this, the interest rates were low. Private banks, scheduled banks, cooperative banks, scheduled cooperative banks, companies, non-banking finance companies (NBFCs), etc., offered slightly higher interest; however, the risk of losing capital with them outweigh compared to nationalized banks.
Tax
Out of the interest yield that I mentioned above, the government levied an income tax varying from 10 to 30% depending upon the tax slab you are in. For any interest receipt beyond Rs 10,000/- in a particular year, there is a compulsory deduction of 20% of the interest if you do not provide PAN to your bank and a 10% deduction if you provide the PAN but did not submit 15H/15G. Assuming that you are in the lowest tax bracket, the tax outgo out of the interest yield of Rs 10,001/- is Rs 1000.10! Effectively, instead of receiving Rs 9000/- for every lakh you deposit, you receive only 8000/- annually or even lesser by a couple of thousands if you are in the higher tax brackets! For the sake of easy understanding, I have excluded any cess or service tax that might be applicable.
Inflation
Whereas if you look at the inflation (CPI), it remained in double digits last year at 10.92%. In fact, if you have kept your one lakh idle at home, you would have lost Rs 10,920/- as its value would have eroded by this time due to inflation and your one lakh would now be worth Rs 89080/- only! Since you deposited it in a fixed deposit and earned 8000/- interest, now you will have 1,00,000 – 10,920 + 8,000 = 97,080. So you actually lost around Rs. 3,000/- of your hard-earned money by investing it in a fixed deposit of a bank! If your income tax slab is 20% or 30%, you are further losing Rs. 1000 and 2000 respectively per lakh a year.
Real risk
So the real return after adjusting for inflation is really negative for investments in fixed deposits of banks, thanks to our government, its tax policies, and its misadministration in containing inflation. It’s taking more from us as indirect tax, through inflation! The retired people who have invested their retirement proceeds to get regular income may have regular and steady income; however, their capital’s worth keeps going down day by day during the tenure of the term deposit. In fact, this is the real risk than losing the capital in case of failure of a bank!
Conclusion:
Hence, in order to avoid this negative return on your hard-earned money, it is always advisable to park only your emergency fund in multiple tranches in fixed deposits of banks. Preferably in multiple banks. In case you need this money for an emergency, you can liquidate them down easily. Otherwise, investing your hard-earned money in fixed deposits of banks is nothing but pure and utter ignorance and foolishness!
Hi Raj,
I just came across your post, very nice! :)
So where should one invest money? Which avenue would give most returns?
Thanks in advance.
Thomas, hope by now you know the power of compounding. Money makes money in a good business and compounds over a long period of time. Look at “good businesses” around you.
Returns that you expect from every other investment avenue would be either based on a “greater fool theory,” “supply-demand mismatch,” or just pure inflationary rise.
Hi Raj,
Does this apply to NRE FDs as well? NRE FD with 9% interest. If FD is locked in for 5 yrs, the compounded amount is good and tax free too.
Please share your thoughts.
For NRIs, investing in FD is a double-edged sword; inflation being one edge and depreciating rupee the other. You stand to lose either way. Let’s look at the two possible scenarios below.
If you want to repatriate the amount on maturity, rupee would have depreciated considerably and you stand to lose whatever you have earned as interest. If you look at the USD exchange rate for the past five years, rupee has depreciated from 45 in 2010 to 64 today, a whopping 42%. So it has almost erased whatever you have earned as interest and you might have been left with a real return of meager 3%. Most banks levy a transaction fee on conversion of Indian rupees to foreign exchange; the range being 2-3.5%. So after conversion, you are left with the same capital or less. For SGD, the depreciation is from 32 in 2010 to 48 today, 50% depreciation of INR against SGD; so a negative return on your FD. Against an ever depreciating rupee, won’t it be wise to hold back the dollars in your country of residence itself and if possible find better avenues for investment there itself?
Now if you do not wish to repatriate the amount on maturity, you would earn whatever interest accrued minus the inflation rate. If the rate of inflation is less than 9%, your real return is the difference between the interest rate of 9% and the inflation rate. If the inflation rate is greater than 9%, you stand to lose by the amount of difference between inflation rate and interest rate of 9%. Eventually it is melting away of your capital gradually without your knowledge or rather is a hidden tax by the government.
Look at the average Indian inflation rate here: It was 10.83, 12.11, 8.87, 9.30, 10.92, and 6.37 from years 2009 to 2014 respectively. Now you may work out the real return earned by you. Thank god, you don’t have income taxes in India as a NRI; otherwise you would have been further made poor with the hidden tax.
So you really gain only if rupee appreciates against other currencies but not in fixed deposits.