Every single penny earned is valuable!! We need money to live so we work hard to satisfy our needs. But what if something happens and we need a huge amount of money at a stretch? Exactly, there arose the concepts of saving, borrowing and lending! But why should I lend when I have to suffer illiquidity and inflation? There again arose a concept called interest/ return. In this way, both lender and borrower enjoy a profitable position. So, if we think of investing in Fixed Deposit (FD), then is it also a type of lending? Yes, we are lending the money to bank and bank lends it who are in need! But are we really enjoying the fruits of saving, parting and lending? Facts reveal that FDs are not that lucrative! Let’s analyse and find why investing in FD’s is not that lucrative.
One fine day, when all of us were busy in my sister’s wedding arrangements, my mom took me to the Bank. She told me that she deposited an amount 10 years ago which had matured today. We went and finally received an amount of Rs. 6,00,000.00. My Mom was quite contented and happy for her wise act of doubling money with no efforts.
Now let’s analyse:-
Amount Invested :- Rs. 3,00,000
Amount Received :- Rs. 6,00,000
Time Period:- 10 years.
Interest. :- 7.2% p.a.
Just like my mom, many other persons thinks they had doubled the amount with minimal or no efforts and feel elated. But is that really true? Had he/she really gained in terms of real value of money? Has my mother really gained value for the money she invested in real terms? The answer is a pure “No”.
Let us explain why her investment i.e, investing in FD is not that lucrative :
-
Low-interest rates:-
The value of money yesterday is not the same today. In this world of increasing inflation, money yesterday has far more value than today owing to the same. Assuming an average 10% rate of inflation for past 10 years, the value of Rs. 3,00,000 as of today is around Rs. 6,50,000. It is because of compounding at the rate of inflation over past 10 years.
Continuing with the previous example, my mom received Rs. 6,00,000 which is less than the monetary value of Rs. 3,00,000 today thereby incurring a loss. In fact, she has incurred loss twice- once when she actually parted with money ten years back and now when she incurred negative returns on the money parted.
-
Illiquid situations:-
Funds once deposited are locked in throughout the term of deposit.Premature withdrawal results in a fee, culminating interest rates or penalty. Thus, when the depositor actually needs money he has to go through a rough time with cumbersome procedures.
For example, take my mom, 4 years back we badly needed funds for my higher studies. In spite of having sufficient balances nothing came to our rescue. This highly illiquid situation resulted in borrowing at a higher rate of interest.
-
Tax implications:-
Interest received on FD’s is taxable. As per the income tax act, if interest payment exceeds Rs. 10,000 in a financial year ,the bank deducts TDS of 10%. Further, 20% for deductee not providing PAN, out of total amount paid as interest.
Now, What is TDS and why it is deducted on FD interest?
Income Tax department has identified certain transactions where the payment of tax burden shifts to payer rather than the receiver. It is done in order to avoid Tax avoidance.As a result, these incomes are taxed in the previous year itself and remitted by the deductor (payer ).
Interest on FD is one such specified transaction.Therefore, TDS need to be deducted by the Banker at the time of credit or payment, as the case may be.
Furthermore, while assessing the total income for filing return, the assessee has to include this income along with his other incomes and compute tax as per applicable slabs. If he falls in the tax bracket of 20% 0r 30% then remaining thereof needs to be paid accordingly.
Example: If we go with our previous example: My mom deposited Rs. 3,00,000.Annual interest will be Rs. 21,600(3,00,000*7.20%) in the first year, which is more than Rs. 10,000, so bank will deduct TDS of Rs. 2160(10%).
Thus, effectively my mother received Rs. 19,440(21,600-2,160).
Now, If I suppose my mom falls under 30% tax bracket i.e. Total Income before interest =Rs. 25,00,000. So, income liable to tax shall be = Rs. 25,21,600.
Then Tax liability shall be :
=12,500(2.5 Lakhs*5%)+1,00,000(5 Lakhs*20%)+4,56,480(Balance 15,21,600*30%)
= Rs. 5,68,980 ( Without EC & SHEC)
From this deduct TDS paid of Rs. 2,160 so, now balance to be paid is Rs. 5,66,820.
Accordingly, the Net effect is that interest amount is taxed at 30% and my mother’s effective return in the first year is Rs. 3,15,120.In other words, the return = Amount Invested add Interest thereon less the amount of Tax paid on it[Rs. 3,00,000+(21,600-6,480)= Rs. 3,15,120].
However, the value of 3,00,000 after one year at 10% inflation rate is 3,30,000 but we have received only 3,15,210. Is it profitable?
Again, Yes in absolute terms and No in real terms. Low return rate coupled with Tax implications at an increasing inflation rate is not a lucrative idea, which may give negative results.
Conclusion :-
When we invest, we invest to earn decent returns, returns which are profitable. Investing in FDs may be good for a person with low-risk appetite, who can part with liquidity for longer times and who have reached their age of superannuation. It’s rationale to invest in FD if you are someone like that, but remember “start investing early so that you can retire early”.
At the initial stages where risk appetite is more, we diversify investing in different instruments and portfolios, take challenges and move ahead. Going for FD’s is absolutely a good idea for people nearing retirement age or who prefers an absolute increase in funds. But, if you want to make a profit out of it, learn to invest in various other options. Be a scientist, first explore for yourself and then conclude.