The other day, I received a WhatsApp message from a senior citizen whose returns from a fixed deposit have gone down by 25%. This difference has come about between a five-year deposit that he made in 2012, and when he renewed it upon maturity in August 2017.
To those who are just reading the headline numbers on interest rates, this may not make sense. Depending on when you are measuring, interest rates have gone down by 2 or 3%. However, here's the exact message: "I was being paid Rs 35,352 every month (subject to income tax) enabling me to lead a worry-free life. Now on maturity I have reinvested the amount in the same bank and I will be paid Rs 26,489
The interest rate on his FD may have gone done by just about 2.5%, but his income is down by 25%. In fact, this is an obfuscation in the way reduction of interest rates is announced and carried in the media. A reduction in the interest rate on a particular kind of deposit from, say, 10 to 8% is a reduction of 20%. If you were earning Rs 20,000 a month, you will now earn Rs 16,000 a month. The 2% reduction is an illusion.
This will give you an amount that is equal to, or more, than what you are earning from a fixed income deposit today. The best part is that the value of the remaining investment will also grow at roughly the inflation rate. If you can implement this, then there is a virtual certainty that you will not be faced with old age poverty. The icing on the cake is that unlike your deposit interest, this income will be tax free.
Retired from the economy
The move towards a lower interest rate economy, while great news for the economy, is of little relevance to older, retired people. Lower inflation and interest rates, better fiscal management and higher economic growth carry no benefit for them because they are no longer in the earning and accumulative phase of their lives. An older person is not going to get a better job or a higher salary because the economy is growing. That phase of his or That phase of his or her life is over.
However, wishing for higher interest rates is no solution. This yearning is there because we have been conditioned to ignore high inflation, the evil twin of high interest rates. I'm sorry to say this, but the person in the above example is financially doomed. For the last five years, when he was getting Rs 35,352 as interest income and spending it, he was actually eating away his capital. Out of that income, no more than Rs 7,000 to 10,000 was real income. The rest was just the inflated value of the currency.
The move towards a lower interest rate economy, while great news for the economy, is of little relevance to older, retired people. Lower inflation and interest rates, better fiscal management and higher economic growth carry no benefit for them because they are no longer in the earning and accumulative phase of their lives. An older person is not going to get a better job or a higher salary because the economy is growing. That phase of his or That phase of his or her life is over.
However, wishing for higher interest rates is no solution. This yearning is there because we have been conditioned to ignore high inflation, the evil twin of high interest rates. I'm sorry to say this, but the person in the above example is financially doomed. For the last five years, when he was getting Rs 35,352 as interest income and spending it, he was actually eating away his capital. Out of that income, no more than Rs 7,000 to 10,000 was real income. The rest was just the inflated value of the currency.
Here's the fact that he and crores others ignore: his real income has probably not gone down. If he was spending only his real, inflation-adjusted income, he would probably find that it has actually increased. And how would he have spent only his real income? The answer is, by spending only about 1.5 % of the deposit per year, and letting the rest compound. This is based on the assumption that FD rates are about 1.5% higher than the inflation rate.
Obviously, he would need far more money to do that. Instead of Rs 40 lakh as deposit, he would need more than Rs 2 crore as deposit, which he does not have. There is no complete solution to this particular case. However, even a partial solution can only come from the returns that equity can generate. Real (inflation adjusted) equity returns are actually double or triple that of fixed income. Where a FD may generate 1.5% above inflation, equity will do 3 to 5%.
There is no way out except to take some exposure to equity in a measured, de-risked and tax-efficient way. First, keep roughly three years' expenses aside and gradually invest the remaining amount into a set of two or three conservative hybrid funds (balanced funds). After three years, you can start withdrawing every year from these balanced funds an amount that is roughly 3 to 4%of the remaining sum.
"If one is to avoid old-age poverty, then this phobia of equity investment in retirement must be gotten rid of. There is no other way."
This will give you an amount that is equal to, or more, than what you are earning from a fixed income deposit today. The best part is that the value of the remaining investment will also grow at roughly the inflation rate. If you can implement this, then there is a virtual certainty that you will not be faced with old age poverty. The icing on the cake is that unlike your deposit interest, this income will be tax free.
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