Fixed Deposits - A Scam?

Fixed deposits(FD) are our parents go-to investment plan. If you ask them, they believe that the FD is the best investment tool out there in the market. At their age, they are definitely right. They can not afford to lose any money. They want to safe guard their wealth as much as possible.

But would FDs be the best place for you to invest? Sure, they protect your money but what is the interest rate they give? Right now as I am writing this, FD interest rate in India’s most prominent bank is between 2.9-5% depending on the tenure. Inflation at the same time is at 7%. FD rates are not even matching the inflation rate. More often than not, FD rates will lie below (at best around) the inflation rate. So, saving your money in FDs is basically losing money with the inflation. Your purchasing power does not increase over time (it potentially decreases). This is great if your priority is to only protect your money rather than growing it.

FDs are a great tool if your priority is to safeguard your money over growth.

Why do banks promote FDs so much? Remember in ”The Secret Banks doesn’t want you to know” blog, we learnt about how banks work. They borrow money from you and lend it out to someone else for higher interest rate. That someone could be you too. What happens with FDs is that they know you wont be taking out your money for that period. It is locked in for whatever period you have chosen for. It only gives them more confidence to invest that money elsewhere. That is why we see the longer the tenure, the higher the interest rate.

Certainly, you may find a few banks giving as high as 8% interest rate. It makes you much more interested to put your money there. A few co-operative banks give higher interest rates. Why are they keen on giving you higher rates than other banks? If you closely observe, the top banks in the country gives the lowest rate of interest. It is simply because they have enough funds already with them and they do not need a lot of infusion. Banks with lower funds* tend to give higher interest rates because they are in need of your money. They can lend out the money to someone only if they have enough funds in their account. This can also mean that the bank is in dire need of the money and hence it is relatively less stable.

One mistake we always do is we believe that FDs are safe. Nothing can happen to banks and the money that we have saved in it, right? That is not true. Remember what happened to Yes Bank and PMC bank? RBI put limit on withdrawals too. That means even if you had 10 lakhs in the account, you could access only 50k. Rest was as good as not being there. Though this would be applicable for just a few days or months, there is no guarantee that you can get all of your money back in these cases. When the DHFL case happened, people lost a large part of their money when a new banker promised to save the bank. That is one of the reasons why RBI insures up to 5L for all deposits.

Does this mean FDs are totally irrelevant to us? or should we not invest in FDs? That is not true. FDs have a defined purpose. If you are planning to get married in a few months and you are uncertain about the economic factors around the world, it is best to start moving your savings or investments into FDs. They safe guard your money better than most other streams. Same goes with your plans on buying a house in a couple of years or planning a higher education next year. FDs are the best place to keep your money if you are retired and safeguarding money is your priority. In fact, it is advisable to store about 10% of your total investment in safer instruments like FDs as a hedge over market crashes. But for young people, it is best to look for alternative investments like stocks to help growth their wealth.

*CASA ratio – Current Account Savings Account. This ratio says how much of their money that they have currently is in these savings account from general public like you and me. The higher the ratio, the better the banks stability.