You are heading for a disaster if you are saving for your retirement!
Are you using fixed deposits to save for your retirement?
If you are doing so, you are in for a rude shock.
Your savings are losing value every day.
Assume you save ₹ 100/- in a fixed deposit for a year at a 6% annual return. You will receive ₹ 6 in interest at the end of the year. If you are in the 20% tax bracket, your post-tax return will be ₹ 4.80 or 4.80%.
Also, assume that inflation over the next year will be the same as the projected CPI inflation for this year, 5.3%. In that case, an average item costing ₹ 100 today will cost ₹ 105.30 next year.
So, while the item’s price would have risen from 100 to 105.30, your savings will have increased to ₹ 104.80 only. As a result, you would have lower purchasing power despite your savings.
The rate of return, after taking taxes and inflation into consideration, is called the “real rate of return”.
In the above example, the real rate of return is -0.50%.
A financial instrument with a negative real rate of return is not an investment at all.
You can use a financial instrument like this as a savings vehicle for your emergency funds or short-term expenses.
However, using them to achieve long-term goals exposes you to the risk of not achieving the goal at all.
Over the long term, a negative real rate of return will compound to widen the gap between the future value of your savings and the future value of your goals.
This anonymous quote nicely summarises it: “Those looking for risk-free returns are more likely to find returns-free risk.”