Principle 9. You are not safe with fixed deposits alone.

Principle 9 is in fact, a continuation of our earlier post on inflation. The reason why we are posting it separately is because there is a certain section of people who think that they are financially safe if they have a regular income from bank deposits or debt instruments. This way of ‘Generating income’ is so popular. World over, people think that if they have a considerable amount in fixed deposits or debt instruments, they are safe. That’s not the real picture. You earn money only if your investment can generate a post tax income which is greater than the average combined rate of inflation and tax prevailing in the country you are living. We will explain that:

Let’s take the example of Mr. A who lives in India:

  • He invests 200,000 in Fixed deposits for 8% interest and gets 16,000 as interest at the end of year 1.
  • But effectively, he would get an amount lesser than 16,000. That’s because of two factors: 1) Income Tax.   2)  Inflation.
  • Assuming that the bank deducts 10% as tax , Mr. A will get only 14,400.00 as interest.
  • Now, the second factor that reduces your income is Inflation.The average inflation rate in India is around 8%.
  • That means, your 214,400 is further reduced by 8% in value at the end of year 1.
  • So your 214,400 gets effectively reduced to 198,518
  • By depositing your money for 8% interest, you dint actually earn anything. in fact you lost 1482 from your capital

Hence if you have all your money in debt instruments like fixed deposits, you’re not safe. You principal amount would keep reducing in value over time. So, the point here is that, you have to look for investment opportunities where you can generate an income that is higher than the combined rate of tax and inflation.

How to check:

Step 1. Multiply the money invest with the rate of interest offered.

Step 2. From the interest amount received in step 1, deduct the applicable tax.

Step 3. Find out the average rate of inflation prevailing in your country ( search in Google, it’s just a click away)

Step 4. Apply the rate to the amount received after step 2 and find the present value.
( how to find present value has been already explained in our earlier posts)

Yes ! It’s time to think smart. You should look at instruments that can at least cover you against inflation and tax.

You may like these posts:

  1. Principle 8. Inflation
  2. Principle 2.Time value of money
  3. Lessons in computing returns – VII Break even return

1 Response to “Principle 9. You are not safe with fixed deposits alone.”

parag ghatode

February 15, 2014 at 5:16 pm

Hat’s off to all of Your article’s Mr. Victor. I am reading it one by one and getting knowledge by all of them one by one. I m not hving gpf or ppf account. Rather than investing in FD is that right to invest in gpf or ppf. Plz give some suggestions.

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