Portfolio Ideas: When should you go for FDs?

August 10, 2015

If your income flows aren’t stable, you may not be able to take more risk. Invest in FDs then

Bank fixed deposits have finite maturity and pay fixed interest. This safety also means lower returns and thus fixed deposits may not always help you achieve your goals.

For instance, you will need a lumpsum investment of Rs 36.89 lakh today to accumulate Rs. 1 crore in 10 years, if you invest 75 per cent in equity and 25 per cent in deposits. On the other hand, you need Rs. 48.69 lakh to accumulate Rs. 1 crore if you invest 75 per cent in bank deposits and 25 per cent in equity. That works out to 30 per cent more in savings requirements.

Besides, fixed deposits do not beat inflation. Suppose you are saving to meet your child’s college education costs 10 years hence, factoring in 10 per cent inflation. What if actual inflation is 13 per cent? But there are circumstances when having fixed deposits is appropriate.

When you need it

First, if your income is volatile. This could be because you earn commission-based income. Or it could be because you work in a highly cyclical industry. Second, if you are a retiree and your primary concern is to fund your living expenses.You should seek stable income products like fixed deposits then. You should, of course, invest small proportion of your portfolio in equity to beat inflation.

Finally, if you have to meet your life goals that have time horizon of five years or less, you should consider investing only in bank deposits to meet your objective, as equities are riskier and you don’t have enough time to recover from any losses.This rule can also be applied to long-term goals that now have a residual time horizon of five years or less.

Risk and reward

You may be tempted to invest a large proportion of your portfolio in bank deposits because of their stability. But remember this: If taking risk is rewarding over the longer term, not taking risk (read: investing in equity) can be risky!

The writer is the founder of Navera Consulting
This article was published on June 28, 2015, in BusinessLine (The Hindu)