Locking FDs during high inflation: What actually makes sense

Smart FD strategies amid inflation

Fixed deposits (FDs) are a preferred investment by safety seekers and risk-averse investors who desire guaranteed returns. During times of inflation, though, the returns that you earn from these could trail rising costs. It raises a fundamental question: is it wise to lock up your funds for the long term, or wait until interest rates shift? It is important to realise the compromise before investing your savings there.

The benefits of long-term FDs

Long-term FDs are safe. Once you lock in a rate, your interest is guaranteed up to maturity date, which gives you some comfort during uncertain times. This might be comforting if safety is more important to you than higher returns in the future. Additionally, banks typically charge marginally more for longer tenors, which may mitigate some of the inflation impact.

The drawbacks of locking in at high inflation

The main risk of locking money in the high inflation is that the real rate of return—the return after accounting for inflation—may be low or even negative. If your FD rate is lower than the inflation, your money becomes weaker over time. Furthermore, if the market rates rise even higher, your locked-up FD may yield less than fresh deposits that offer higher rates.

Balancing growth and safety

One is to consider laddering your FDs. Spreading your investment in diverse tenures, you are able to earn prevailing rates with elbow room to reinvest on better rates in the future. Another way is to mix FDs with other low-risk investment vehicles that are inflation-indexed, such as short-term debt funds or inflation-indexed bonds, which can neutralize erosion in your purchasing power.

Making an informed decision

Whether or not to accept long-term FDs in periods of high inflation is a personal choice depending on your objectives, level of risk tolerance, and liquidity requirements. If safety and certain return are the highest, then long-term FDs are also available. If beating inflation and retaining purchasing power are top priorities, then a liquid or diversified approach will be more advantageous.

FAQs

Q: Can long-term FDs erode in value because of inflation?

Yes, if the inflation rate is higher than the rate of interest, the real return decreases.

Q: What is laddering of FDs?

Laddering is a strategy of splitting deposits in multiple FDs of varying maturity periods to reach a balance between returns and convenience.

Q: Alternative to long-term FDs during high-inflation times?

Yes, they do have short-term debt funds, liquid funds, and inflation-indexed products, which are more protected from inflation.