Should I open a Fixed Deposit?
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We Indians typically have a savings-oriented mindset. Most of us have grown up with kiddy banks as gifts and have memories of breaking open kiddy banks on special occasions. That permeates into all that our parents taught us through example – buying Gold, putting money away in small deposits, recurring post office options, senior citizen plans, salary-cutting LIC policies, Kisan Vikas Patras etc. Today, our avenues of investment have opened up big-time but our mindset hasn’t changed too radically. We still remain the same savings-oriented economy which is mostly investment and risk averse. It isn’t wrong, but it is necessary to rethink this as interest rates are at an all-time low!
We would probably remember that our parents times had interest rates of 11 and 12%. Most of us would remember 9%+ rates as it was just a couple of years ago. Then they’ve dropped rapidly and we’re around the 5% mark today. There is clamour for further cutting of rates and while there isn’t too much scope, we can’t rule out a further 0.5% cut. So that would make fixed deposits earn interest rates that we were making on savings accounts till a few months ago!! So is it worth investing in fixed deposits?
Let’s take a step back and understand what a fixed deposit is meant to do, and how interest rates are set by the RBI. When the Govt decides to give a bond at a fixed rate, or set an inter-bank rate, or guarantee a deposit, it does that specifically with the annual inflation % in mind. The simple goal is to make up for what inflation takes away. Thats it. In 2010, our inflation rate was almost 12%. Fixed Deposit interest rates were around 10.5%+. Senior citizen and special deposit deposit schemes would make a bit more. Our inflation over the last few years has dropped significantly. Whether that is good or bad is for another blog post. But the deposit rates kind of shadow these rates and hence have been dropping in order to bolster credit available to SMEs, entrepreneurs, and to customers to build homes and buy automobiles. Banks’ primary purpose of collecting deposits is in order to lend them back into the market at a slightly higher price. So when credit rates fall, deposits are bound to fall even more. That’s what is happening currently.
Ideally, a % of your savings should be in a fixed deposit. That % would vary depending on your age and the financial priorities / goals you have for yourself and your family. If you anticipate having a large expense coming up in the short term, you wouldn’t want to put money in the stock market or equity mutual funds as those are volatile and also susceptible to charges. But is 5% good enough for you to lock in money into a fixed deposit? Actually, yes, it is. Because the Govt anticipates that the inflation over a rolling period would be around the same percentage. So in effect, you’re not growing your money, but trying to maintain that amount at its current value, if inflation stays that way. So though your ₹500000 may become ₹600000 in some time, the value of it is probably similar to what you set out with. But a fixed deposit is an important part of an investment basket. It lends the investor the ability to hedge against a riskier investment. It also is stable and has added benefits – like a loan against or a credit card against (we will talk more about unlocking value of a fixed deposit in the next post).
So yes, you should have some portion of your savings in a fixed deposit. What was earlier 70-80% should now ideally come down since the rates are so low. If you are young, have less in FDs and more in moderate to aggressive investment options. As you grow older, shift more of your portfolio into debt. There are debt funds which give a couple of percentage points more than a traditional fixed deposit, and there are also government-backed GILT bonds and funds which typically make a bit more. But those are not as liquid as an FD and more importantly, they don’t add to the relationship with your bank, which may give you additional benefits. In conclusion, work out a percentage. Decide how much you want to invest in aggressive options and how much in safe options. Lets say you want to hit an annual return of 9-10%, spread it around into multiple options in your investment basket – equity, bonds, deposits, and gold – and aspire to that number you have in mind.
Read this to help you further –
