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Fixed returns: Victims of inflation!

November 17, 2003 13:06 IST

Sad as it may sound for investors who have spent a lifetime investing in fixed return schemes, the harsh reality is that fixed return schemes are no longer attractive options.

Investment avenues that offer fixed returns have borne the brunt of the softer interest rate regime.

Also there are factors over and above the softer interest rate regime, which place the fixed return scheme's utility under doubt. A closer look at each of these factors will help us strengthen this contention. Inflation is an element, which is almost never factored in while assessing the fixed returns of any scheme. The post-inflation returns can make most assured return schemes look like poor propositions for the investor. The table shows what 'real' returns a fixed deposit investor earns assuming an inflation rate of 4%.

Inflation adjusted returns
Period12 months24 months36 months
FD rates6.00%6.25%6.50%
Less: Adjustment for
Real returns2.00%2.25%2.50%
Period12 months24 months36 months
FD rates5.50%5.75%6.00%
Less: Adjustment for
Real returns1.50%1.75%2.00%
(FD rates as on September 2003)

Critics might argue that the above table is misleading as corporates offer fixed deposits at higher rates. However the risk borne by the investor goes up substantially as in most cases the 'higher return' deposits are unsecured by nature. Hence, in case of default, the investor might lose not only the 'fixed return' but also the capital invested.

Also the liquidity aspect of these schemes could be a cause for worry. In most cases a pre-mature withdrawal attracts a penalty.

Investors will have to start looking at other options to reverse the downside of fixed return schemes. Income schemes offered by mutual funds are the best bets for these investors.

Safety and stable returns are the major factors drawing investors towards fixed return schemes; this is where income schemes have an edge over other investment avenues. Since income schemes invest their corpus in government securities, bonds and debentures they are the closest to being risk-free. There are relatively scant chances of an investor losing his capital.

Leading fund managers like Rajat Jain (CIO- Principal Mutual Fund) believe that retail investors can invest in income funds for better and tax efficient returns. Clearly income funds are better equipped to counter inflation. Another distinct edge income schemes possess is the liquidity available to the investors on account of the exit option. For bearing a slightly higher degree of risk, income fund investors can be rewarded by returns that fixed return schemes could only hope to match.

The transition from fixed returns to market driven ones can be an unnerving experience for most first timers. Income schemes provide the perfect platform to make this transition. This is one step investors should take if they wish to meet their financial goals.

Click here to compute your real returns.

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