Our economy is going through troubled and challenging times – low growth rate and the falling rupee has left very few investment options for us- the retail investors. In 2012,
Equity markets – were volatile and the future trend unclear
Real estate- Sluggish
Gold – Prices have barely moved much
Fixed Income – The interest rates are on a downtrend
For ages, bank fixed deposits have been popular among investors as a safe and hassle free investment haven. People are so comfortable placing their money in deposits that they often do not consider investing in debt schemes and other comparative products. This could be because of lack of awareness or because of the following features which seem to make fixed deposits attractive.
- Fixed deposits are safe – Banks in India are regulated by the Reserve Bank of India and in the event of a bank going bust, DICGC (Deposit Insurance Credit Guarantee Corporation) covers all fixed deposits to the tune of Rs 1 Lakh. This is applicable per depositor in a bank inclusive of principal and interest.
- Ease of operation – Fixed deposits is a simple product easy to start and can be closed prematurely at any time by the depositor.
- Fixed rate of return – While applying for a deposit, the investor knows the rate of return and the exact maturity value which he would get at the end of the invested period.
- Tax benefits – Some special fixed deposits in banks with a lock-in of 5 years are eligible for income tax rebate of up to Rs 1 Lakh under section 80 C.
Now, the drawbacks –
- Lower tax adjusted returns – The interest earned on fixed deposits is fully taxable as per the investor’s tax bracket, hence the post tax returns are low.
- Effect of Inflation – The prevailing high inflation rates in our country (8 % currently) and the low post tax returns ensure that the real rate of return is negligible, if not negative! This means that your money does not grow at all.
- The guaranteed fixed return means that the depositor doesn’t have a chance to earn higher returns than that promised. In the past, during a falling interest rate scenario govt. securities with lower risk have given double digit returns, and during rising interest rates in the economy floating rate debt funds have done exceedingly well. But those who were invested in fixed deposits during these times still got only the fixed interest rate.
- On premature closure of fixed deposits, most banks charge a penalty which the investor has to bear, apart from getting a lower interest rate applicable for the period for which the deposit stays with the bank. For Example – If I open a fixed deposit for Rs 1 Lakh @ 9.5 % pa for 3 years, and am forced to close the deposit after an year, not only would I have to bear the penal charges of say 1 % for pre-closure, the entire 1 lakh would earn only an interest of 8 % pa applicable to deposits of 1 year duration. In effect, I would have earned only a gross interest rate of 7 % pa.
In conclusion, a word of caution.
Co-operative banks, especially the unscheduled ones are best avoided though they offer rates of return which are as much as 2% pa higher than other banks. During the last year 2011, 9 co-operative banks have closed down. This figure was 19 in the year 2009. Getting the insurance money on bankruptcy is also not easy. The Reserve Bank of India first tries to revive the bank and in the event of liquidation, the insurance money is released only on completion of the liquidation process which means the investor could have to wait for a long time to get his money back.