It happened to be one of those breaks where I take a couple of days off from work and visit my parents in Lucknow.
This was my first trip after having switched jobs and subsequently cities (Delhi to Bengaluru). Soaking in the January Sun, I was talking to Dad and sharing my experiences at my new work place.
Considering the fact that the financial year was about to end, he inevitably asked me about how I am managing my finances in the new city and the savings/investments I had made this year.
To my utter disbelief, he was appalled to hear that most of my investments were made into mutual funds and that I had not made any investments in a bank Fixed Deposit (FD).
To add to it, I realized he had a never ending list of the FDs that he had made, across tenures.
This discovery about each other’s investment choices, led to an extremely challenging and intriguing discussion. While talking to him I realized, that majority of us Indians still take the conventional route of investing in FDs, letting the value of our hard earned money actually depreciate!
Although it was a herculean task to make him hear anything against the safe and secure investment avenue that he had been turning to since ages, I highlighted the following few facts which turned out to be an eye opener for him.
#1: The Real Rate of Return
As per my Dad’s belief, FDs are the safest investment instruments in the market. It came as a shocker to him when I informed him that FDs result in loss of money over the long term.
The average inflation rate in India for the years 2013-2015 is approximately 7.72%. Most FDs give about 8.5% returns before tax and 7% after tax.
The value of any investment made today, diminishes over time due to inflation. The real rate of return accounts for the returns earned post tax and adjusts the total return on investment for inflation.
Keeping these stats in mind, the real rate of return is actually negative as post tax returns are lesser than the average rate of inflation.
#2: Tax Implication on FDs
Similar to being oblivious about inflation, this is also something that my dad had never given a thought to. He could not believe that equity Mutual funds that generate average returns of round 12-14% are tax free in the long term. Obviously he did not deny the fact that he has been paying taxes as per his tax slab on FD returns.
Debt mutual funds (which are similar to FDs from a safety perspective) held for more than three years, are more tax efficient - thanks to the indexation benefit! Investment in an FD of a 3 year tenure on the other hand, undergoes tax implications at the end of each year, yielding lower returns.
In comparison to the FDs that fall under 80C and have a lock-in period of 5 years, these schemes have a lock-in period of only 3 years.
This thought provoking discussion that stretched over the entire afternoon, pushed my Dad into a pensive mood. The fact that mutual funds can be a better bet against the safe, bank backed FDs, was disturbing for him.
It’s not easy for our parents or for that matter, for anyone of us to break away from something conventional that has been validated for generations.
But with a little data and some calculations we can show them a better way.