Rising𝓰 🐲inflation and tax can take a huge bite out of your investment
With retail inflation hovering around 5-6 per cent in recent months, and occasionally crossing the 6 per cent mark, investors who invest in fixed-return instruments like fixed deposits should be worried. In fact, according🍸 to the latest report by the State Bank of India, the real rate of return on bank deposits has remained negative ༒for a considerable period.
Let’s try to understand this with an example. If you invest Rs 1 lakh today in a fixed deposit earning you an interest rate of 5 per cent, your investment will grow to become around Rs 1.64 lakh in 10 years. However, according to your annual income, you will have to pay tax on your return of Rs 64,362. If you fall under the 20 per cent slab, the real return from your investment over 10 years would be Rs 50,975, reducing your total corpus to around Rs 1.5 lakh. On the other hand, if you fall in the 30 per cen♊t slab, your final corpus would be just Rs 1.44 lakh.
Now if we take into account the effect of inflation, the value of Rs 1.5 lakh, 10 years from now, would be just around Rs 87,000, if we consider the current rate of inflation, that is 5.3 per cent. And if your final corpus is Rs 1.44 lakh (if you fall in 30 per cent tax slab), its value after 10 years would be equivalent to around Rs 83,534. So, essentially, if you invest Rs 1 lakh in fixed deposits for 10 years, you may end up with a corpus smaller than your actual investment in real terms. This is how the negative real rate of return plays out🅺.
Now interest rates vary from bank to bank, which would marginally impact the value of the final corpus depending on your bank. But the trend essentially remains the same. For instance, SBI offers an interest rate starting from 2.9 per cent, for deposits with short tenure of 7-45 days, to 5.4 per cent for tenures ranging from 5-10 years. Some private banks are offꦚering a 5.5 per cent rate of interest for tenures up to 10♌ years. Even in the best-case scenario of a nominal return rate of 5.5 per cent, the real return translates to a loss of Rs 10,000 over 10 years, according to bac- of-the envelope calculations.
According to Archit Gupta, Founder and CEO, Cleartax, rising inflation can imp𝓀act your long-🉐term financial goals if you invest predominantly in fixed-income assets. It is because inflation eats into your returnS and you take a long to attain your financial goals.
“You will have to change your strategy by investing in inflation-indexed bonds that adjust the principal and interest for inflation. Investors with a 💜higher risk tolerance can invest in equities for inflation-beating returns over time,” he said.
According to the SBI report, it is time to revisit the taxation of interest on bank deposits. “Real rate of return on bank deposits has been negative for a sizeable period and with RBI making it abundantly clear that supporting growth is the primary goal, the low banking rate of interestꦆ is unlikely to make a northbound movement anytime soon as liquidiℱty continues to be plentiful,” said the report.
The report also pointed out that the negative return from bank deposits could be among the reasons “for households to divert funds to the stock markets for m🎀ore returns”. “This implies that the current bull run in financial markets is possibly a break from the past as households may have got into the bandwagon of self-fulfilling prophecy of a decent return on their investment,” it explained.