Inflation – does the word ring any bells? In the post-Covid era, which witnessed a probable K-shaped recovery, many of us have been brutally hit by this problem. Be it food, energy, health, or education, the rise in prices has caused global mayhem, resulting in rising interest rates across the world. But how does inflation exactly affect us?
Let us dive a little into the concept of dosa economics introduced by Mr. Raghuram Rajan, the renowned ex-RBI governor. Suppose a person has INR 1 Lakh in his bank account today, which they invest in a fixed deposit yielding 6% return per annum, while the inflation is at 8%. Also, let us assume that the person consumes only dosas every day, and each dosa costs INR 60. Using this 1 lakh, the person will be able to buy 1666 dosas immediately. Or, they can wait till the end of the year, which is when each dosa will cost INR 64.8. The person’s total FD investment will be worth INR 1.06 Lakh at that point, and they will be able to buy 1635 dosas only!
This is how high inflation eats up the capital, thereby affecting future purchasing power. And how does one manage to beat inflation? By chasing higher returns on their capital. However, higher returns come with a pinch of salt, which is the looming risk associated with the instruments that generate them.
Fixed deposits, (FDs), have been a traditional method of investment in our country for decades now. Since childhood, most of us have been encouraged to save and invest in FDs, because banks hardly pay any interest on our savings lying in their accounts. But do FDs benefit us in the long run? Before moving to any kind of conclusion, let us first understand what FDs are and how they work.
Fixed deposits (FDs) are a tool for investment provided by banks, post offices, and non-banking financial companies (NBFCs), which offer a certain percentage of fixed return over a specified period or tenure. All these entities generally use the money raised through these FDs to run their operations. It is almost like a loan that we give to these entities, however, we get the entire return and principal paid at maturity only. There are provisions to withdraw early too, which come with some kinds of penalties or charges generally.
Just like FDs, corporate bonds are a tool for debt investment provided by corporations and banking/non-banking entities. Similarly, the capital raised through bonds is utilized by these entities to run their operation and/or do some kind of capital investment. Corporate bonds generally provide a higher rate of interest than FDs. Moreover, many of the bonds can even be liquidated in the secondary market, thereby providing the investors the option to take an early exit without incurring any kinds of penalties, and with minimal charges (mostly transactional and taxation).
Corporate bonds also provide the option to receive monthly/quarterly/annual coupon payments. This enables the investors to recover some part of the capital even before maturity, thereby reducing the risk involved.
For someone seeking just capital preservation and not worried about beating inflation, fixed deposits certainly provide a good investment option. However, the investor must be wary of the fact that FDs are not very liquid in nature, and might harm their returns to a great extent if exited prematurely.
For most investors, based on their entire portfolio, it is important to have a proper mix of FDs and corporate bonds in their investment basket. Both instruments are generally devoid of the kinds of risks that are present in the equity markets. In case an entity issuing bonds gets liquidated, then their bondholders are given preference for payment over the shareholders.
Just remember, every day that goes by without investing properly adds a certain percentage point in favour of inflation. So, go out, find a credible financial advisor, and get a comprehensive diversified portfolio designed for yourself!
Or explore and invest in lucrative investment opportunities giving inflation-beating returns via Grip.
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