If there is something that Indian parents pass onto their kids unfailingly, it is their love for traditional insurance policies and fixed deposits. I have already written about LIC policies and why ULIP plans are easily one of the worst places to park your hard-earned money. Now given how deeply Indians love fixed deposits, it is imperative to analyze why fixed deposits are no better in their wealth-destroying magic as ULIP plans. So, without much ado, let us begin.
Before we understand why fixed deposits are a terrible investment choice, it is important to understand why they are so popular among people in the first place. If you ask any Indian why they have put their money into fixed deposits, you will get the same reasons listed below:
They are safe:
Often safety is cited as the most important reason why people choose fixed deposits. As the name suggests, "fixed deposits" are fixed income instruments. They are offered by various banks, as well as Non Banking Financial Companies (NBFCs). All fixed deposits have different interest rates based on their tenure, amount, and the institutions they are provided by. Often, senior citizens are given an additional rate to entice them. In any case, they are all sold as "safe" investments, unlike the stock market where you can lose all your money, and your car, and house too. (You will hear this most from people who have actually lost a lot of their hard-earned money in the stock market by treating it like a gamble - which, guess what, you shouldn't. Read on here to know other massive but very common stock market mistakes)
2. High interest rate:
Now, this is something only a person who has never been exposed to the world of equity or who has run away from it say. But still, this is often cited as a good return compared to bank rates. And yes, that much is true. Add to this return rate the words "risk-free" and you have a killer product in your hands.
3. Well, that' it, to be honest.
To sum up the reason why fixed deposits entice investors like a beach entices a young boy, its "risk-free, safe, high returns." These same reasons are also true for a few other fixed income
Now, if I want to convince you to stop putting your money in fixed deposits, I need to convince you that the main reason of "risk free high returns" is not as good as you might think. And frankly, it's not very difficult to do so.
Are fixed deposits really safe?
In the past few years, Indians have seen various banks collapse, even those that seemed infallible at one point. So, even though you might think fixed deposits are very safe, they are only as safe as the institution they are offered by. You might be aware that the Reserve Bank of India guarantees an amount of 5 lakh per investor per bank within the DICGC (Deposit Insurance and Credit Guarantee Corporation) scheme. But if you have more thank 5 lakhs in a fixed deposit, the rest of it is not insured. Also, if you have put your money into any NBFC, no part of your money is really guaranteed so you are pretty much as safe as you would be in the stock market. So, if you are putting in money in an FD thinking it is safe, think again.
2. Are the returns really high?
Most fixed deposits offer anywhere between 6.5% to 8.5% interest. This may look better than the measly 4% that you get in savings account but it isn't that better. Wealth creation only happens when the returns on your investment is higher than the rate of inflation. Generally, inflation rates in India hover around 6 to 7%. So you are barely fighting inflation, atleast on paper. But wait, this isn't actually the money you make. Even though the FD generates the said return, you don't get that amount in your hand as the interest earned on FDs is taxable. It is taxed under the "Income from other sources" category. And what's worse, you may even have to pay TDS in addition to the income tax if your interest in an FD is greater than INR 40,000.
If these reasons weren't bad enough, another major problem with FDs is their utter lack of liquidity. FDs are notorious for being very illiquid, meaning money once put into them cannot be taken out before the end of the tenure. If you are in need of money for any emergency, pre-mature withdrawal of fixed deposits may even lead to penalties which may be 0.5-1% of the interest. If the fixed deposit is broken within 6 months, no interest is paid on it, meaning your money actually lost value in those six months, courtesy of inflation. You will come out with lesser money than you went in with.
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So, if you look at fixed deposits objectively, you'd see that they are hardly a lucrative place for parking your hard-earned money. With its low returns, high taxation, and illiquid nature, FDs should be a relic of the past, a mistake of our parents we dare not repeat.
If you are now more confused than before on where to park your money, you may check out these articles on: How to start investing in your twenties and A case for mutual funds.
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