I have come across people who often complain about their money not growing. This is a very common thing, and today I will try to shed some light on this issue.
All the investment products comes with its merits and demerits. Some are high on risk and so give better returns as well. While with the safer investments returns will always below. Now when I speak about returns, please note that there are two kinds of returns. One is the perceived returns other is the real return.
Ok, so what do I mean by this?
The answer is quite simple. Let me put it this way, supposing one decides to make investment in Bank Fixed Deposit and, say the bank is offering an interest rate of 8.25% per annum on its fixed deposit for a period of say three years. This 8.25% is not the actual returns on your investment, it’s a perceived return. You have not factored in the tax implication and the inflation on this. When you apply these two parameters your actual returns will be different. To illustrate this let me consider the following example.
Suppose you want to invest Rs. 100, 000/- for a period of 3 years @ 8.25% per annum (simple interest) in a bank fixed deposit. So the amount you will receive on maturity is Rs. 124, 750/-, this will be mentioned in your fixed deposit certificate.
Now if you are in 30% tax bracket you will have to pay tax on the interest earned, which comes to about Rs. 8167.50/- (including cess & surcharge) thus now the interest earned has come down to Rs. 16,582.50/- To this amount when we apply an inflation which is Rs.15,122.50/- (from Year 2014 through 2016) the actual amount that works out is Rs. 1,460 /-
So you see, Rs. 24,750/- which you initially saw is the perceived returns while Rs. 1,460/- is the real return that your investment actually will give. So how do you decide which investment product should you choose? Well, that depends on the time you want to invest for and also the amount of risk you are willing to take. If your investment horizon is short term, say less than three years, better stick to fixed deposits or Mutual funds debt funds. If it is between 3 to 5 years you may opt for balanced and or diversified equity mutual funds. For tenure, more than 5 years you may consider investing in equity-oriented mutual schemes and shares. These, my friends, is only a general guideline and not an investment advice or recommendation. The idea is only to make you aware of the fact that please factor in the inflation and tax implications before you make any investment decision when planning for your various financial goals. And, please consult your financial advisor before making any investment decisions.
I hope you will choose wisely where you invest your hard-earned money, so that your money works harder for you than you work to earn it.
P.S:- Cost Inflation Index (CII) for each year is published by The Government of India, Ministry of Finance (Department of Revenue), Central Board of Direct Taxes, and can be accessed online.