Last week someone asked this question in a comment. More specifically: The person estimates that if his daughter were to be married today it would cost about Rs. 5 lacs. He has this 5 lacs today, and wanted to know what would happen if he deposited this in a fixed deposit and took it out after 20 or 25 years.
Will inflation eat into the earnings, or will the interest rate from the fixed deposit be enough over such a long term to beat inflation.
I can’t think of a time in the last five years or so when you could make more in fixed deposits than inflation, but then we all know that people have a short memory and your memory is always colored with what happened recently.
This question is one of real interest rate (Nominal Interest – Inflation), and I looked to see if I could find this data over a really long scale.
Here is what I found on the World Bank website:
- World Bank Data on Real Interest Rate in India
They describe Real Interest Rate as follows:
Real interest rate is the lending interest rate adjusted for inflation as measured by the GDP deflator.
I will dig deeper into these numbers and their definitions in a later post, but for now I wanted to show that in the past we’ve had better real interest rates than what we see now. And if oil prices don’t spiral totally out of control, we will probably see the end of the high inflation period we have seen recently.
That said, the way these numbers are calculated lend me to believe that just putting money in a fixed deposit and earning interest on it will not suffice.
So, what should you do?
The thought of getting into equities is tempting, but for someone who is looking at fixed deposits as an end - I’d not recommend that. You’d lose too much sleep and probably won’t be able to handle the volatility the share market brings with it.
Personally, I’d recommend saving more.
Yes, I know we’re not in a recession any more, and this kind of talk is not sexy these days, but you have to understand that there is risk in equity, and you should be able to handle it.
There is no point in getting into shares if you can’t handle risks, and I don’t think you can handle risk very well if you use the money that you’re counting on to conduct your daughter’s wedding in the share market.
The volatility will drive you insane.
Save more, build a buffer, and then if you have money that you think you can lose without losing your sleep over it – enter equities.
Remember, it’s the good times when you get an opportunity to save more and build wealth – times such as these when everyone is talking about hot stocks are the times when you get carried away and make bad decisions.
Stick to the basics; be thrifty, and everything will fall in place.
Thoughts?
One can barely meet inflation if one invests only in FD. However, most people still do that and lock there money for a long time. By the time, they get the returns, value of money has already gone down much more. Checkout the link to get another perspective.
Investing in PPF is much better than going for FD
Hi Ujjwal,
The interest rates in FD would be changing always and it would be tempting to spend once you have the money in your hand. Its always better to save in long-term plans like PPF which would be tax free as well (tax free is not necessary in your case, though), in case if you are planning for something big after 15 years.
If you want to have only safest return in one year, FD is the best and its better to have it in your father’s name who might be over 60 years of age to get that extra 0.5% benefit.
Manickkam.
Delighted to see all the spirited discussion here. Thank you all for your inputs.
The only thing I’d like to add is to not overly rely on the WPI figures for inflation, as that may not have captured the high inflation we see in real terms every day. So, 8% is good, but will probably not be enough if things continue like this.
thanks sir,
it is your and others blogs that have made me interested in financial management….may god make you a wealthy person…
Thanks Ujjwal 🙂
With all these suggestions about SIP, it could be worth your time to look into Value Averaging Investment Plans. I believe currently, Benchmark offers this investing model in India.
And Ujjwal, the idea of earning 25% per annum from your own equity market investments from the onset might be a tad too ambitious :). Be prepared for losses too when you start on your own. Starting with paper trading is a great idea but it does not fully prepare you for the actual market. Not deriding paper trading but just telling you what you could expect.
Take care and Good Luck with your investments! Its nice to see you are giving so much thought to your financial future.
dear sir,
i know getting 25 % is not easy…..but it is possible…
what i think economy and banks are inseparable…as money is generated and circulated by banks…so, if economy grows, banks will get maximum benefit….
so, if i choose only banking sector and then also top 5 PSU banks…..and study the historical price series, then what i noticed that if you have long-term view, you can easily make 25 % yearly after taking entry at any level ( considering economy will grow in long-term) …..
so, my strategy will be only concentrate on 4-5 good banking share, study them carefully. get news about them like everything, and fix your profit margin and invest.
there is no need to diversify in case of direct equity investment nor to waste you energy by tracking lots of stocks….as you are doing this diversification through your mutual fund investment…
but of course, it is easier to say than do…
but this is my thoughts…..and i am going to implement it step by step……
Nice to know you have a definite plan ujjwal. I would just recommend that along with the profit margin, also have a stop loss in place.
Good Luck!
yes sir you are right….
thats good thought Ujjwal, you dont need the advice I have given..:-) ….I dint see your reply before posting mine..all the best !
thanks Hema for giving me really one good advice….whenever i will get good return from direct share investment, i will divert that money into RD, FD or any other safe instrument..
or i will plan keeping both things in my mind….
Ujjwal, You should think over what Pallavi has suggested. You need not invest your 5 lakhs into the share market but if you are thinking of saving more over a long term, instead of a recurring deposit you will be better off if you invest in a SIP in a Equity Oriented Hybrid fund or a balanced fund which is not high risk. May be you can research a bit on which funds would suit your needs. See which funds have done well irrespective of the ups and downs of the market over a long period. There are some funds which have been around for more than 15 years and have given good returns over the years. Also, check how they are doing currently in the last 6 months or so to see if some changes have occured in terms of management etc like Pallavi has suggested. This will give you an idea of which ones you can safely invest. Since you are looking over a long term like 20 years you need not fear volatality as much as for short term, if you look at the maket over long term volatality has not eroded peoples funds unless something drastic happens like in Japan. Also when your goal is near, make your funds safe from short term volatality by diverting into a FD etc.
Just a suggestion Ujjwal, look at taking the SIP route and invest in large cap mutual funds. Thatways you are not managing your portfolio and hence no chances of loosing sleep and looking at the past performances of large cap mutual funds we can confidently say that they have bailed out a lot of people from there financial troubles. I would suggest pick and choose a couple of large cap funds and monitor them on a 6 monthly basis for management changes and substantial allocation changes. Volatility is good when we take this route and in the current market we cannot avoid volatility so we should try to utilise it the best way possible.
thanks pallavi for your suggestion….upto now i never invested in equity market….and after reading various material, what i have learned that it will not be wise to start invest in direct share now…so, it will be better to invest in mutual fund now in SIP route and study study market and when you will be ready start…in this way you will get some benefit of market and will not loose much money….
as i have told i have become an ardent fan of goal-based finanacial planning.
i have already set various financial goal…
out of which, one is within 15-20 years, i should have 1 crore rupees wealth…this have no serious use like marriage of my daughter or retirement or vacation in europe..this is only for just a feeling wealthy.
so, having this goal in my mind, what i have decided, after i get my job in august-october 2012, i will start SIP in these 5 mutual find rs 3000 per month total 15,ooo per month.
1) HDFC top 200 2) BSL dividend yeild 3) UTI dividend yeild 4) HDFC prudence/ HDFC equity 5) reliance banking/ uti banking.
right now, 7 days back, i have applied for demat and olt in canara bank as its annual maintenance charge is 200 rs, its brockerage is 0.25 % ( for our type of investor who will invest occasionaly) and mutual fund investment is totally free.
and after i will get the account, i will start SIP in the MF,s 500 rs per month ( because this is max i can afford now…i am doing 5000 per month RD at 10 % for 1 yr with Karur vaishya bank)…totalling 3000 rs per month in MF. afterwords, as my income will increase, i will increase it.
and if i get 15 % return from my mutual fund investments, i will have 1 crore rupees after 15 year. ( is i am wrong in my calculation please tell me …then i have to rethink)
and again after 2-3 year when i will be ready to invest stock market directly. i will invest rs 3-4 lakhs. and i will expect average 25 % return per year, then also after 15 years i will have 1 crore rupees with me.
i case of MF, i have nothing to do except periodically checking the fund’s performance, but out of 5 ,4 MF are running for last 10-15 years. and they giving consistently above 20 % return. so, reliable.
and for share, what i have decided for this 2-3 years i will increase knowledge, will chalk out investment policy and do paper-trade. then only i will start investing ( one reason is that i donot think, before 2-3 years , i can manage 2-3 lakhs rupees extra money which i can afford to loose) …and i have decided to follow value-investing method, so that i will not have much adrenaline rush.
thats all about what i am thinking…as i am new to this financial thinking…i am enjoying it very much…
p.s–just joking….as in bank rs 1 lakh is insured. i will require 15 different branches of bank to ensure that my money is ultra-safe.
p.s—get the annual average inflation from RBI
rbidocs.rbi.org.in/rdocs/Publications/PDFs/80219.pdf
so practically, for the high income people who gives income tax, the bank fixed deposit will not able to beat inflation or just loose to inflation or marginally beat. there will be no wealth creation at all. but if you are tax-free it will certainly beat inflation by very little margin.
in my case, what i have planned, i wll follow goal-based financial planning.
if my goal is marriage of my daughter, i will not take any risk of equity market because seriously, i will loose my sleep. what i planing to do for this goal.. is that,
i will search which bank is giving highest interest rate for 1 year tenure. and i will Do Recuuring deposit of 4000 per month. and then will invest in fixed deposit ( i have thought of some criteria to decide FD tenure and bank) after one year ( i will not be able to generate lots of money in a one month) . and i will invest the money through my father or mother. both are outside taxable income and will submit form 15G or 15H to avoid TDS.
if both my father and mother dies before that, i will invest that money into debt oriented mutual fund or will find new things which are safe, tax-free and just give enough interest so that my money do not decrease in value.
this way i will be able to generate rs 30 lakhs after 20 years.(considering the current bank FD rate ) ( and considering the average inflation of 8% i will require 24 lakhs after 20 years ). and in future, if the inflation rises, bank rate will also increase. and if inflation decreases, bank rate will also decrease. and i will sleep very soundly in night.
Dear sir,
thank you very much for answering my query in a such elaboarte way…i agree with your suggestion to save more and only entre into share market when if i loose money, i will not loose my sleep…i am planning to do exactly like that…i will invest only that money which have no importance to me…i will never invest money for marriage of my daughter or something like that….
[[[[ i am 30 years old….married with 2 years old daughter…i do P.h.D in bangalore and get UGC scholership of 20,000 . my wife is a govt school teacher in my native place and earns 25,000 . recently sir, my wife required some money as she have to help one of her student by lending him 50,000 rs for his education expenditure. but then both of us realised that we do not have enough liquid cash or savings…we have to take money from our friends to give him the money….and that hurt me very much. ]]]]]
then i thought, i have to change now….and now i am reading various blogs, materials etc etc.
now, coming to my query…..after 1 month of googling, what i came to know that lakshmi bilas bank is giving g 10.1 % interest rate in 1 year deposit…canara bank is giving 9.5 % ( think twice) interest in 8-10 years period. now i also checked that current inflation is 8.89 % ( which is higher than long-term average)
you can see the inflation rate of india from 1969 and note that current inflation is highest in this decade and higher than total average. the long-term average of inflation of india is 8 %.
http://www.tradingeconomics.com/india/inflation-cpi
and what i can remember that there were 12 % interest rate in NSC 10 years before…so, bank interst in always higher than inflation.
so, if you just want to beat inflation and you have no intention of wealth creation, bank fixed deposit will certainly do that, there is no doubt in my mind. as i feel, bank decides its interest rate only to beat inflation. also take care that money do not get devaluated. but if you give tax ( say 30 %) ( in my wife’s case 10%…myself is totally tax-free upto now) on the interest earned, then your money will decrease in value.