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Blind faith in Fixed Deposits is destroying wealth

As per a recent newspaper report, 116 of the 526 co-operative banks in Maharashtra are in serious trouble. 22% distressed banks is no small number. Of these 106 are facing liquidation and 10 are under RBI-appointed administrators.

As such, crores of rupees of fixed and savings account deposits, belonging to thousands of ordinary account holders, are facing grave threat.

Therefore, I wonder why people have so much trust in FDs and why they love it.

One. Every single rupee of the interest earned on fixed deposit is taxable

There is simply no tax relief on interest income. Therefore, depending on your income bracket, your tax liability could be as high as 30% (+cess and surcharge, if any). FDs in the names of spouses and children are not only a misplaced notion of love and affection, but can also invite tax-man's wrath if you don't club it with your income.

After paying taxes, the interest income is normally in the negative territory, when compared to inflation. In other words, as years go by, your bank deposits will not be able to keep pace with the rise in prices. As such, your day-to-day requirements will slowly but surely go beyond the reach of your bank balance.

Excessive love for Fixed Deposits among Indians is indeed baffling.

Two. And not to forget, you are penalized if you wish to take your money back before the due date. Premature encashment has two problems. One, you get lower interest rate as applicable to the actual period of deposit and not the contracted rate. Two, there could be a penalty too on early withdrawals.

As can be inferred from the above, the supposed safety of fixed deposits is a myth. Not only is there a direct risk of loss if the bank goes bust, but also the risk of erosion in its purchasing power.

Three. Then we come to the inconvenience of TDS (the dreaded Tax Deducted at Source).
- If TDS is not applicable to you, you have to furnish 15G / 15H form to all the banks individually so that they don't deduct TDS on your interest. And this has to be done every year, year after year. That's not all. Wrong deductions are not uncommon. Which means you have to claim refund when filing your tax returns. All in all, a pretty cumbersome affair.

- If TDS is applicable, you have to collect TDS certificates from all the banks individually at the end of each financial year. Even if there are no errors or omissions, this again is a pretty cumbersome affair. And God save you if there are mistakes.

Despite all the risks and troubles, Indians invest 90-95% of their surplus money in fixed deposits.

Are there any "better" alternatives?

Of course, there are...
... Debt mutual funds will eliminate many of the problems associated with FDs without compromising on the returns.
... Arbitrage funds (I wrote about them a few weeks back 'Arbitrage funds : Excellent way to park short-term money'.)
... Instead of chasing the extra 1-2% returns in risky FDs from co-operative banks, NBFCs or companies, it makes lot more sense to consider mutual funds' Monthly Income Plans. (True, MIPs take a marginal exposure to equity. But isn't it logical to buy shares of a good company / bank than to do FD with a bad one.)

In such a scenario, this excessive love for Fixed Deposits among Indians is indeed baffling.

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