Is investing in FDs alone enough?

by Manshu on April 26, 2011

in Economy

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
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?

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