Honey, we don't have any money left for the kids!

Abhijit Chandrasekaran

Ananya Mittal

Wednesday August 30, 2017 , 7 min Read

“The great long-term financial risk isn't losing your money; it’s outliving your money!” – Nick Murray

The above quote — by a celebrated financial services veteran — has never been more relevant for the Indian ‘aam-aadmi’.

For most of us Indians, losing our hard-earned money is one of our biggest fears. After all, our hard-earned money is our only cushion towards a secure future for our old age and our kids. More so, having money (or so-called bank balance) is a source of many intangible benefits as well — self confidence, societal acceptance and respect (an unfortunate reality), and more.

No wonder we look for the safest options possible to park this money whenever we decide to invest. There’s nothing wrong with this thought, except the fact that our definition of ‘safety’ is at times misguided.

Let us consider a simple example. Let’s say in order to protect my wealth, I stash bundles of cash in a very secure private vault. This way I might ensure that I don’t lose a single note I hold. However, with time, the same note is now worth a lot less than it was when I parked it. The reason: inflation. So, in spite of keeping my money as safe as it can possibly be kept, I have still lost it.

So what was the traditional financial instrument that used to give us this cushion against inflation? It was the bank FD. Does it still exist today? Yes, it does. So what’s the problem now? Interest rates are falling, and hence bank FD rates are falling too!

Yes, interest rates are falling. Much to the disappointment of our moms and dads, bank FDs, post office savings schemes, Public Provident Funds, National Savings Certificates, Kisan Vikas Patras, and even our savings bank accounts, all offer much less today in real value than what they used to 10 years ago and significantly lower than what they did 20–30 years ago.

People from our grandparents’ or parents’ generations will tell us that they never had to look beyond the nearby bank (in most cases a nationalised bank) to park their savings and make sure their social obligatory financial needs and post-retirement lifestyle needs were easily met. These were sustainable financial and wealth planning measures for the Licence Raj era. Private sector banks were hardly present. Foreign banks were never heard of in India. Stock markets and bond markets were underdeveloped.

In short, there were hardly any market-based investment alternatives and opportunities available. Even those that existed were available only to a select few. The rest were just not attractive enough in comparison to the high FD rates (>12 percent per annum for many years) as well as the guarantee and security offered by banks and provident funds that were run by the government. Moreover, inflation levels did not bother anyone, for they were never so close to the FD rates. Large joint families in itself provided the structure support and cushion, where the better-earning members balanced the lesser earning to ensure a fairly predictable lifestyle for a foreseeable future. Financial planning and goal setting were never heard of.

But things have changed. The India of today is not the same as the one 30 years ago. In a macro sense, economic reforms have opened doors for many and harnessed competition across industries, including financial services. Closer home, we have nuclear families that plan for themselves. Banks, microfinance institutions, insurance firms, mutual funds, brokerages, portfolio managers, and alternative investment funds are all there to serve the various needs of people from every economic stratum.

It may be comforting to know that there are so many firms around to help us with any financial or investment need, but on most occasions, it’s simply overwhelming. To give you some perspective, take just one option — mutual funds. In this, there are more than 11,000 investment schemes. Add to this the fact that there are already close to 100 prominent public sector, private, and foreign banks in India offering fixed deposits, giving you the comfort of the known way for you to park your wealth.

In spite of so many offerings to help us better manage our finances and risks, our moms and dads are not happy. Their investment, or rather saving instrument of choice — the bank FD — is slowly turning out to be inadequate against high inflation, higher social obligations, and the new-age lifestyles most of us have adopted.

Currently, bank FDs offer close to 6.5 percent for one–three years — pre tax.

In-hand returns after tax deduction are in the range 4.9–6.3 percent depending upon your income tax slab. This is dangerously and disappointingly close to the RBI inflation target of five percent, which means that even if the RBI manages to keep inflation around five percent over the coming years, you would hardly earn anything if you park your money in a bank FD. (In fact, you would lose money in real terms if you come under the 30 percent tax bracket!)

For those still keen to invest in bank FDs, the long-term future is not bright either. Here’s why:

From a high-interest rate, controlled regime to a low-interest rate, growth-focused, open economy, India has come a long way. There is still a long way to go and barring global hiccups like the 2008 financial crisis, a low-interest-rate regime is likely to continue in India for long. This will remain a reality irrespective of which political party forms the government in the future.
With banks reeling from high non-performing assets (NPAs — which always existed but were never accounted earlier!) they cannot afford to be liberal in doling out fresh loans to individuals and corporates without adequate due diligence. This means higher costs for banks and hence they can ill afford to offer attractive FD rates in the future (which is a cost for a bank as well!) without any more incentives from the RBI.
With the coming of age of robust, world-class bond markets in India, debt mutual funds have evolved as a very attractive alternative to bank FDs. Debt funds offer well-diversified portfolios of government securities, treasury papers, and corporate bonds that are managed full-time by extremely efficient and highly-qualified teams of top finance professionals. They are much more skilled at identifying market opportunities as well as balancing risks than you as an individual and therefore make sure your money is well placed and earning well at all times. In most cases, they manage to yield more than a bank FD rate. Government incentives in the form of a tax benefit on returns after three years from debt mutual funds is an additional challenge bank FDs have to overcome.
Lastly, the government’s concerted push towards a cashless economy is going to be the final nail in the coffin for bank FDs as a good investment alternative. Banks today (post-November 8, 2016, the fateful evening when demonetisation was announced) are flush with cash, and with consumption levels in India having taken a hit for the last six months, they are under tremendous pressure to manage costs while not letting the NPAs rise. Even if many banks manage not to drop their FD rates in these times (which is unlikely but possible!), they are certainly not going to offer higher ones.

Who is likely to get impacted the most? The moms and dads, i.e. the middle-aged and senior citizens not accustomed to and uncomfortable investing anywhere other than traditional bank FDs. Many are living in denial of the ground realities. It is time they accept the new-age economic realities and adapt, rather than complain and get left behind.

And it is our responsibility, for once, to teach something to our elder generation and lead them on a path towards a more secure and better financial future. More so, make them trust in us and our abilities to take the country forward towards growth and prosperity.

Make them believe in you and consider the newer and better investment alternatives available today rather than get left behind and risk losing their wealth to inflation through traditional investment choices.

Let us conclude with another Nick Murray’s quotes most relevant in today’s times and one that can help you make your case in front of elders: