Traditionally, most Indians are comfortable parking their savings in bank fixed deposits (FD) or small savings schemes of India Post. In the 80s, people did not have easy access to equity market and the equity/debt market was not well developed. Our forefathers were biased towards safety and security of the principal amount. The added incentive was also high interest rate given by banks at that time. Coming back to the present era, many low-risk investors and savers still choose bank FDs. People who have fear of losing money invest their savings in FDs as these bring guaranteed returns. There is nothing wrong or right about it. It all depends on an individual’s preference. Theoretically, there is no risk of losing money with bank FD although people do tend to forget inflation.
Returns and inflation
The tenure for bank FDs ranges from 7 days to 10 years. The average interest rate for minimum 7 days is 4.45% while for maximum 10 years it is 6.5%. For senior citizens, it’s more but just by a fraction. One of the disadvantages of investing in FD is the taxes that eat up a part of this interest. So one should compare post-tax FD returns with current inflation. It will be difficult to keep up with real inflation by just putting your hard-earned investment in bank FD. India’s real inflation on paper is 4.87% but to be honest it’s on the higher side of above 5%. So if we deduct inflation from post-tax FD returns for a long tenure, there isn’t any room to enjoy those interests as it hardly beats inflation. The only advantage is the safe principal amount and nominal guaranteed returns. If we look at the Nifty, it has generated CAGR (Compound Annual Growth Rate) of 12% for the last 20 years and 5.5% since 2007-2017. Generally, people do tell that market gives you 12%-15% returns in 10 years but picking one particular Nifty 5 years or 10 years returns will not give a clear picture.
Higher returns in equity
We need to see how market behaved in all such periods. If we look at the returns since 2009-2017, Nifty was trading around 2965 and currently, it is trading at 10,800 so that is an absolute return of approx 265% and annualised return around 12.83%. What about the negative returns in 2007-2008? So when we look at last 20 years the picture gets clearer. Nifty still generated decent CAGR of 12%. That is way ahead of long-tenure bank FDs. Comparing FDs with debt funds, one has to pay capital gain tax as and when withdrawal is made in debt funds. Also debt funds don’t generate as much returns as equity. Bank FDs also play a very minor role in tax-saving as there are tax-saving fixed deposits with 5-year maturity period. There is hardly any noteworthy interest difference between regular FDs and tax-saving FDs which can attract investors. There are better instruments for tax-saving like tax saving mutual funds. Of course, we cannot compare bank FDs with equity mutual funds as they are two different instruments. It is like comparing apples and oranges. The only point we would like to make is that if you are looking to park your money for long-term goals like children’s education, their marriage or your retirement, FD is not an appropriate instrument. It will hardly cover your future needs. Higher post-tax returns in the long term are generated by equity and not by fixed deposits. It’s still fine for short term (preferably shorter than three years). But FDs should be really avoided for long term. If an individual is interested in maximisation of post-tax returns and does not want to risk capital, bank FDs are ideal instrument for the short term.
The writer is director & COO, Tradebulls Securities