What exactly is wealth? As per Investopedia, wealth measures the value of all the assets of worth owned by a person, community, company or country.
We commonly associate wealth with the amount of money an individual or family possesses. But, the appreciation of wealth is just as much a science as it is an art.
A common misconception amongst investors is that “preservation” of earned wealth is the same as a generation of wealth. The same statement is unfortunately false.
A common man will always feel that his earned wealth is secure in the form of fixed deposits (FD) in a Public Sector Bank (PSB). While the notion is correct, a combination of mathematics and economics will try to counter that argument.
When a middle class Puneite earns his salary, he pays tax on the same. His post-tax income is a generation of wealth. But, if the same is depleted it is loss of his wealth. Unfortunately, the notion is to preserve the same and hence it is parked in Fixed Deposits and Recurring Deposits. But, is the interest generated on those debt instruments helping to generate wealth? Let’s find out!
Assuming we deposit Rs 100 in a fixed deposit in your nearest bank and assuming you get an interest of eight per cent, your earning will be Rs 8. At the same time, as per the taxation laws prevailing the country, the same interest is taxable as per your tax slab. Assuming you are in 30 per cent tax bracket, you will end up paying Rs 2.4 to the government. So what you get in hand in form of interest is Rs 5.6. But is it really a growth of Rs 5.6? Let’s dig a little deeper…
We all are familiar with the term inflation, which basically tries to measure a general increase in prices and a fall in the purchasing value of money. Since India is a growing economy, we are stuck in a higher inflation bracket. As per latest government bond yield data, which accurately reflects the inflation picture of the country, the rates were at seven per cent, which considers all the commodity prices, fuel prices, wage inflation, etc. all factored in one rate. Assuming the inflation is at seven per cent, that means what costs Rs 100 today will cost Rs 107 tomorrow. This means investing in a Fixed Deposit it will be Rs 1.4 or 1.4 per cent of the value of FD behind the average expense increase of the country.
So from where will this shortfall be met? This is met from your Fixed Deposit. Unknowingly, as time passes to meet increasing expenses, with your base principal of Rs 100, you start withdrawing the shortfall of Rs 1.4. This is known as devaluation or debasement of your principal. So in the long term, a person’s wealth doesn’t appreciate and he is unable to fight daily expense rise. Does that mean all your Fixed Deposits are horrible investments? Absolutely not! A certain amount of Fixed Deposit is required for emergency expenses, short term goals and other purposes, but other than these few reasons, fixed deposits can never help in appreciation of wealth.
Another viable solution to the same is investing in alternative debt instruments with tax efficiency to help boost your portfolio returns. One must consider going for debt mutual funds (liquid funds, government bond funds, corporate bond funds) the same are debt instruments if held for three years can give you indexation benefits which helps reduce your tax liability to a minimal level. Another viable option is arbitrage funds which can give you risk-free and tax-free returns after one year of holding.
There are also some funds available which gives a combination of both the above for bond funds and arbitrage funds.
Always remember, the aim should be to file tax on the source of income, (in case of salaried people, it should be in the form TDS deducted) post that, the wealth or savings must generate tax-free income which will have a long-term compounding effect to the wealth as there are conservative tax efficient options available in market that needs to be grabbed! If you are interested in learning more about the pros and cons of fixed deposits it is a good idea to check out a variety of deals. Don’t forget to read the fine print!
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