Understanding How Inflation Affects the Real Returns on Fixed Deposits

Posted on Sunday, April 14th, 2024 | By IndusInd Bank

A high inflation rate can significantly affect the real returns on a fixed deposit as the real value of investment decreases over time. As a result, investors need to consider the impact of inflation on an FD before making an investment decision. Investors can opt for cumulative FDs with high interest rates and tax-saving benefits with IndusInd Bank to maximise their returns and potentially offset the impact of inflation.

Fixed-income investments like fixed deposits are often a top choice for individuals seeking stable and steady returns. While their ability to offer consistent returns attracts many, one critical factor to consider before investing in fixed deposit accounts is inflation.

Inflation is the steady increase in prices that can affect the purchasing power of money. When prices for goods and services increase, each currency unit buys less than before. This also impacts your investment returns, which need to outdo the rate of inflation to maintain or increase their actual value. As is the case with any investment, high inflation can significantly affect the real returns on your FDs. While investors may receive a steady return on their investment, when adjusted for inflation, the actual purchasing power of those returns decreases. The investor may find that their funds haven’t grown as expected, potentially resulting in erosion of wealth over time.

As a result, investors need to consider the impact of inflation on FD before making investment decisions. This article will discuss how inflation affects fixed deposit interest rates and real returns.

How Does Inflation Affect Fixed Deposits?

Fixed deposits carry a fixed interest rate that reflects the rate at which the money will grow over time. However, to truly gauge the value of an investment, one must consider the real rate of return, which considers the impact of inflation. Real returns are calculated by subtracting the inflation rate from the nominal interest rate.

Here are ways in which inflation can affect FDs:

1. Decrease in real returns

High inflation rates can significantly affect the real value of an investment. Since the fixed deposit interest rates do not change over time, the investment might not grow as much as expected, resulting in low real returns.

2. Decline in the purchasing power

Inflation leads to a decline in the purchasing power of money. For instance, an FD offers an interest rate of 6%, and the inflation rate is 5%. While the FD will fetch 6% returns per annum, the purchasing power of returns would only increase by 1% per annum.

3. Risk of negative real returns

If the inflation rate is higher than the fixed deposit interest rates, investors have the risk of negative real returns, and the investment will lose its value in real terms.

How to Mitigate Inflation Risks

While inflation poses a risk of lower real returns to investors, various strategies can help maximise returns. Here’s how:

Opt for higher fixed deposit interest rates

A higher FD interest rate is one of the most important considerations in beating inflation. IndusInd Bank offers fixed deposit schemes at relatively higher interest rates. By choosing a high-interest rate fixed deposit, investors can potentially offset the effects of inflation and secure more attractive real returns.

Depositors can easily book an FD online with IndusInd Bank by submitting their PAN and Aadhaar card details.

Consider Shorter Tenures

While long-term FDs may carry slightly higher interest rates, they are also more vulnerable to the impact of inflation. Short-term fixed deposits, available through IndusInd Bank, provide the flexibility to adapt to changing economic conditions by offering better liquidity.

In periods of rising inflation, opting for shorter tenures allows investors to reinvest the funds at higher rates when the market changes.

Choose cumulative fixed deposits

In cumulative FDs, the interest is paid at maturity by compounding the interest quarterly and reinvesting to the principal amount. Unlike non-cumulative FDs, which offer regular interest payouts, this strategy helps maximise interest income and results in higher returns at maturity.

Invest in a tax-saving FD

Tax-saving FDs with a lock-in period of five years can help reduce the taxable income. The principal amount qualifies for tax deductions under section 80C of the ITA, allowing investors to maximise their post-tax returns and counteract the impact of inflation to a certain extent.

Open a Fixed Deposit Account with IndusInd Bank

Fixed deposits are among the safest investments available, offering guaranteed returns. However, inflation can significantly erode their real value and affect their returns. Thus, it is important to pick FD schemes that can help maximise returns over time, such as the IndusInd Bank fixed deposit that offers the following benefits

• Three-step hassle-free FD account opening online
• Video KYC facility
• Best-in-class interest rates
• Auto-renewal with multiple interest payout options
• Flexible tenure
• Availability of tax-saver FD for 5 years

Book today!

Disclaimer: The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. Hence, you are advised to consult your financial advisor before making any financial decision. IndusInd Bank Limited (IBL) does not influence the views of the author in any way. IBL and the author shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any financial decisions based on the contents and information.