How inflation kills FDs and how senior citizens can work around it

Fixed deposits, on the other hand, are financial instruments offered by banks where you deposit a lump sum amount for a fixed period at a predetermined interest rate. They are preferred for their stability and guaranteed returns, making them a go-to option for risk-averse investors, particularly the elderly.

Fixed deposits have been the go-to investment option for a large segment of the Indian population, especially senior citizens, due to their perceived safety and guaranteed returns. The idea of locking in a sum of money at a fixed interest rate, with the promise of getting back the principal along with interest at maturity, offers a comforting predictability. However, this comfort comes at a cost, often overlooked – the cost of inflation.

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The real impact of inflation

Consider an investment of Rs 1 crore in a fixed deposit at a six  percent annual interest rate. At first glance, this seems to offer a healthy return, but when you factor in an annual inflation rate of five percent, the real scenario begins to unfold.

At the end of the first year, your FD investment grows to Rs 1.06 crore. But when adjusted for inflation, the real value is approximately Rs 1.01 crore. This slight increase in nominal terms is substantially offset by inflation, showing a minimal real gain.

By the 10th year, your pre-inflation return is Rs 1.79 crore, but post inflation it’s just 1.10 crore. Despite the nominal increase, the real purchasing power of the investment barely grows, underscoring the insidious effect of inflation.

By the 20th year, your pre-inflation return is Rs 3.21 crore, but post inflation it’s just 1.21 crore. Inflation has eaten away nearly Rs 2 crore from- or 62 percent of- your FD returns.

These calculations underscore a critical point for Indian retail investors, particularly senior citizens who rely heavily on fixed deposits for their post-retirement income. While the nominal value of investments in fixed deposits may appear to grow, inflation significantly diminishes their real value and purchasing power over time. This phenomenon effectively eats into the savings that many depend on for their daily expenses, medical costs, and other necessities.

Also read | Fixed deposit platforms make investing easy, but limited offerings a drag

Senior citizens: unsuspecting victims of inflation

Many senior citizens, post-retirement, prioritise capital protection and regular income flows in their investment choices, primarily opting for fixed deposits. The assurance of a fixed return often eclipses the subtler, detrimental effects of inflation on the investment’s real value.

For seniors with fixed deposits, the interest income often becomes a significant portion of their financial sustenance. Consequently, a situation where the post-tax returns from FDs are in negative contrast to inflation directly jeopardises their financial stability. In times of high inflation, the interest earned might be insufficient to cover the increased cost of living, compelling them to either dip into their capital or compromise on their standard of living.

Why seniors are particularly vulnerable

Senior citizens often choose fixed deposits for their apparent stability and steady income through interest payments. However, they are the most vulnerable to inflation risk for several reasons:

Fixed income: Post-retirement, most seniors rely on fixed income sources like pensions and savings, with limited opportunities to earn additional income.

Longevity: With increasing life expectancies, the risk of outliving one’s savings is real. Inflation exacerbates this risk by reducing the real value of money over time.

Healthcare costs: Seniors face rising healthcare costs, which typically outpace general inflation rates, further straining their fixed incomes.

What should senior citizens do?

Diversifying portfolio: Instead of relying solely on fixed deposits, consider diversifying your portfolio. Include assets such as mutual funds, stocks, REITs, gold and bonds, which historically have offered better returns over the long term compared to fixed deposits.

Systematic withdrawal plans (SWPs) in mutual funds: SWPs allow you to invest in a mutual fund with proper asset allocation and systematically withdraw a fixed amount. This can be an alternative to the regular interest income from FDs, potentially offering better post-tax returns.

Inflation-protected securities: Consider investing in inflation-indexed bonds which adjust the principal and interest payments for inflation, thereby offering a hedge against the eroding value of money.

Stay informed: Understanding the dynamics of inflation and its impact on savings is crucial. Regularly review and adjust your investment portfolio to ensure it aligns with current economic conditions and your financial goals.

Consult experienced financial experts: Experienced financial experts can provide personalised investment strategies with proper asset allocation that take into account your financial situation, risk tolerance, and the impact of inflation.