Why Fixed Deposits May Not Be Suitable for Your Investment Portfolio

Fixed deposits (FDs) are often considered as a safe and secure investment option, offering a fixed rate of return over a specified period. However, in today's competitive investment landscape, FDs may not be the best choice for many investors. Here’s why FDs might not suit your investment portfolio, considering various factors such as risk appetite, time horizon, and expected rate of return.

Understanding Investment Criteria

When evaluating investment options, several criteria are typically considered, including:

Risk Appetite: Your tolerance for investment risk. Time Horizon: The period for which you plan to invest. Amount Invested: The capital you have available for investment. Expected Rate of Return: Your target rate of return.

Expert financial advisors often emphasize that it's not necessarily wrong to avoid fixed deposits if other factors such as risk appetite and time horizon are taken into account.

Considering Factors Before Choosing Fixed Deposits

Expected Rate of Return

Currently, fixed deposits typically offer a rate of return ranging from 7% to 8%. While this can seem attractive, it's important to compare this with other investment options. High-quality mutual funds, for example, can offer returns exceeding 12%, or even up to 15% in certain market conditions. Thus, the rate of return provided by FDs is often lower than other investment avenues.

Taxation Considerations

The interest earned from fixed deposits is subject to tax at the applicable rate. If your income tax slab is 30%, and the interest rate on your FD is 7%, your effective return would be 4.90%. On the other hand, long-term capital gains in mutual funds and shares are taxed at a flat rate of 10%, even if you fall under a higher tax slab. This makes mutual funds and shares a more tax-efficient investment option.

Wealth Creation

Fixed deposits take a long time to create wealth. An annual return of 7% will double your investment over approximately 10.2 years. In contrast, returns of 12% would double your investment in just 6 years, and 15% would achieve this in around 4.8 years. Therefore, fixed deposits offer a slower path to wealth creation compared to other investment options.

Keeping Up with Inflation

While it's advisable to have investments that provide returns higher than the inflation rate, fixed deposits may not be sufficient. If the current inflation rate is 9%, the post-tax return on 7% FDs (which is effectively 4.90%) would result in a depreciation of your wealth over time. This makes investing solely in fixed deposits a less effective strategy for wealth preservation.

Risk Management

Risk management is a crucial aspect of investment strategy. Financial advisors often advise investors to diversify their portfolio to manage risk effectively. Placing all your eggs in one basket can be detrimental. Instead, it's recommended to distribute your investments across different asset classes, including fixed deposits, shares, mutual funds, and gold. This approach not only minimizes risk but also maximizes potential returns.

Comparing Liquidity

While fixed deposits offer guaranteed returns, other investment options like shares, mutual funds, and gold also provide reasonable liquidity. In today's digital age, all these assets can be easily liquidated within a short period, making them comparable to fixed deposits in terms of liquidity.

Conclusion

Fixed deposits, while offering a risk-free return, can be a less rewarding investment option. To optimize your investment portfolio, it's essential to consider factors like inflation, taxation, and your time horizon. By diversifying your investments and considering various other options, you can maximize your returns and build a robust investment portfolio.

Remember, keeping a well-diversified portfolio not only mitigates risk but also helps you achieve your financial goals. Invest wisely and happy investing!

Thanks and Regards,

Pragya K.

Financial Advisor