Are fixed deposits a bad investment option?

If you ask anyone from our parents' generation on investment advice, their first go-to suggestion would be Fixed Deposits (FDs). But there's a lot of backlash these days against FDs as an investment option. Why has this image of FDs changed over the years? Why was it so popular in our parents' generation and why are people against it now?

To understand this, you need to know that the India we see today is not the same as it was during our parents' time. India opened up its economy in the 1990s after which it allowed globalization to enter the country to streamline a lot of processes and make life simpler. Thus there was a lot of friction involved in a lot of these other investment instruments.

Today, only 27% of Indians are financially literate (note that we're not even talking about financially educated, just literate). So it's easy to imagine the percentage of people that were financially literate in the past.

Due to the amount of friction involved in other investment options coupled with unawareness about the impact of inflation, FDs seemed like the easiest no-risk investment option.

Today, a lot of people talk about investing in stocks and bonds. But we need to realize that the process of buying stocks and bonds was much harder back then. People had to physically go and place an order to get a stock. The stock would be given in a physical form which had to be then kept safe. Information was not as readily available as it is today. Charges on everything were much higher. This was the case even up until a few years back. Zerodha came and reduced the charges drastically, making the entire stock buying experience much more simpler and cost-effective. Also, risk management has never been taught in schools in India and money has been looked at from a negative angle. Hence, no discussions on it contributed to this lack of awareness.

Hence, with a lack of awareness, friction in the stock market trading, and lack of risk management skills, FDs found an environment to thrive in the past.

Now that we have access to information at the tip of our fingers, stock market frictions have reduced drastically and financial awareness is increasing, is there still any place for FDs?

But why are FDs bad? To understand that, we need to understand a concept called inflation. Inflation is the value your money holds. For example, 10 years ago, you could buy a 500ml cold drink bottle for Rs.20. Today the same cold drink costs around Rs.40. 10 years ago, you could buy a lot more with Rs. 100 than you can today. Thus the value that each rupee provides has reduced. This continuous decrease in the value of money is what's called inflation. That is the reason why everyone talks about investing. Because if your money is sitting idle in your account, you're losing money because its value keeps reducing.

The average inflation rate in India stays around 4-6%. This means if you're investing your money and making a return of less than 4-6%, you're losing money in that investment. FD return rates in India are generally between 3-5%, hence people recommend against FDs.

But does that mean you should take all your money out of FDs and invest in the stock market? The answer is no. Because even though the stock market can give you a better growth opportunity, it also comes with an added risk of losing money. Hence there are situations where FDs can be a better investment option:

1. You're already invested in the stock market and have some extra cash you can't afford to lose but also don't have any immediate requirement of can be put into FDs.
2. You join a new company and receive a bonus with a clause to return it in case you leave before the agreed period. You can put your money into an FD for that period. Once it gets over, you can choose to invest it in riskier sources.
3. If you've recently started earning, FDs and RDs (Recurring Deposits) can be a great way to witness the power of compounding first-hand to let you dip your toe in the investing world to provide you some confidence before diving into the stock markets.
4. If you don't have enough knowledge about the stock market and are currently learning, putting your money in an FD will provide a better return than letting it stay in your savings account.
5. For anyone who doesn't want to take risk, for example, people in their 60s or 70s, FDs are a much better option as they provide a stable interest rate.

Hence, even though a lot of people advise against FDs, it all depends on what your goal with your money is. If your goal is to beat inflation and grow your money and you're okay taking risk and losing money in the short term, FDs aren't the right resource. But if you want a completely safe instrument with no risk, FDs can be considered as an option.