Is FD still a wise choice of investment?
In India, FD(Fixed Deposit) is considered the safest and most common method of investment. According to a SEBI survey in 2019, 95% of Indian families prefer bank FDs, and less than 10% prefer mutual funds and stocks.
Here are some reasons why people prefer fixed deposits over stocks, mutual funds, and nifty indexes.
- Money can be parked without worrying about returns or market volatility.
- It is convenient and reliable because it is provided by banks, and people trust banks.
- It provides assured returns along with the safety of the principal amount.
- Investment period can vary from 7 days to 10 years.
- It allows a tax deduction for up to Rs.150,000 under Section 80 C of the Income Tax Act, 1962. However, premature withdrawal is not allowed from these FDs.
Next, let’s examine the performance of FDs over a period of time
From the above charts, it’s visible that the FD returns are decreasing over time, and currently, it’s lower than the inflation rate, which implies that we are essentially losing money instead of saving if we are investing in FD.
Let’s compare the return of FD and Equity over the period of 20 years.
The above table is a scenario where an investment of Rs 10,000 is made every month for 20 years. Taking it as Rs 1,20,000 per year for ease of calculation and presentation. Due to the fact that interest is calculated annually rather than monthly for ease of purpose, the actual numbers may fluctuate a bit
The final value of Rs 10,000 per month invested in FDs with a 6% interest rate(the current rate is at 5–6%) vs Rs 10,000 per month invested in equities with an average return of 13% per year compounded annually for a period of 20 years.
Simplified Math behind the arrived values
Compound interest simply means the interest is earned not only on the original principal but also on all interests earned previously. For instance, at the end of the first year, your amount would be 1,20,000+15,600(15% interest on 1,20,000) = 1,35,600. For the second year, you would have (1,35,600+1,20,000) + 33,228(15% interest on 1,35,600) = 2,88,828.
Now that we have understood the power of compounding and investing in equities, we shall now take some more experiments to see how the time factor combined with the power of compounding, can create massive wealth over a period of time.
Let's extract the final value of our investment from the above table and understand how we can multiply the returns further with time and compounding.
That’s a return of 2.2 times more than FD. But does the 2.2 times return outweigh the risk of market volatility?
Let’s extend the 20 year investment horizon to 40 years. Let’s observe what happens to your investment if you would have continued investing the Rs 10,000 investment for a period of 40 years.
The value of our investment after 40 years would be Rs 13,74,58,295. That is 7 times more return than FD. I just took into account the 13 percent minimum return of nifty. Between 2002 and 2012, the average annual return for the Nifty was 14%, whereas from 2012 through 2022, it was an average of 18%.
With a return of 18% the value of the final investment after 40 years would be 105,45,75,986, which is 55 times higher than a fixed deposit.
Why are Equity investments risky and how to reduce the risk?
Here’s how the 1 year graph of FD return looks compared to the 1 year graph of nifty returns.
It seems the FD chart is consistent, whereas the Nifty chart is very volatile in nature. Bare with me for the next few minutes, where we will uncover the secret behind the long term game and how to tackle the volatility of the market by almost doing nothing.
The above graph represents the absolute return of nifty for each year since the inception of the market. We can see that the nifty gave varying returns throughout the year, ranging from -51% in 2008 to +75% in 2009. We also can see the pattern of massive returns after each fall. Each fall is an opportunity to invest as the market always recovers and reaches new highs from each low.
10 year Rolling return
Rolling return for a period of 10 years is a return calculated by taking the average of nifty return over the previous 10 years. For instance, the 10 year rolling return of nifty for 2021 will be the average of the nifty return between 2011–2020. By doing this, we can see the smoothened graph, which represents how nifty has performed for a period of 10 years.
Let’s look at the 10 year rolling return of nifty over a period of 10 years between 2011–2022
This chart shows that if we park our money in equity for any period of 10 years, we are guaranteed a return of 13%. Over the past 2 decades, FD returns have declined, while Nifty returns have remained consistent at an average of 13–15%.
Now that we have seen the difference in returns and the risk between FD and equities, let’s have a basic understanding of the meaning of terms like equity, nifty and stocks and investing in equity/nifty.
Equity, Nifty, Stock, etc., what are they?
The Nifty 50 index is an index that represents the 50 largest companies by market capitalization. A company’s equity is its total value after deducting its liabilities (debt). When a company registers to become listed in the stock market, they divide its total value into n stock/shares, each with a specific price. Investing in equities simply means investing in a company by purchasing one or more shares/stocks of one or more companies in the share market.
In addition to the multifold returns offered by equities over FDs, let’s examine some other advantages.
Investing in Equity is the way to escape inflation and diminishing FD returns.
- When there’s inflation (rise in the prices of commodities or raw materials), the business passes it on to the customers. We, the customer, will be paying high prices. Once the price of the raw material eases off, the business won’t reduce the price back to normal. Instead, they keep the profits. If we invest in these businesses instead of investing in banks, we can utilize the inflation to our benefit. as the business shares its profit among the shareholders.
- Moreover, whenever there is an economic crisis, the government decreases the returns of FD and other government schemes, thereby taking away the money from us. Again, the way to escape from this hurdle is to invest in businesses, as the government won’t let businesses fail, and the businesses won’t let the investors fail.
Conclusion:
If you are investing your money for the long term, it is better to invest in equities rather than FD, as the risk is close to zero in both the investments and Equity provides multifold returns than FD in the same time period. For a shorter period of investment(1–5 years), one can choose between PPF, Treasury bills, Debt funds etc over an FD for safer and better returns.
Further articles will discuss alternatives to FDs and types of equity and non equity investments in detail, as well as how to invest in them.
New to trading? Try crypto trading bots or copy trading on best crypto exchanges
