How to Plan for Inflation-Protected Returns with High-Interest Fixed Deposits

In recent years, India's inflation rate has risen noticeably, prompting the Reserve Bank of India (RBI) to raise the repo rate by 250 basis points from May 2022. As a result, many banks and NBFCs have significantly increased their fixed deposit interest rates.

Inflation can erode the value of your hard-earned money, affecting the growth of your investments and returns over time. To protect your investments and ensure safe returns, it is crucial to plan for inflation-protected options. 

One such option is investing in high-interest fixed deposits. In this article, we will explore how inflation affects FD returns and provide strategies to plan for inflation-protected safe returns with fixed deposits.

Understanding Inflation's Impact on FD Returns

Inflation refers to the increase in prices of goods and services over time, which reduces the purchasing power of money. When you invest in fixed deposits, the interest rate remains fixed throughout the tenure, unless you break your FD before maturity . But, if the inflation hedge is higher than your FD's interest rate, the value of your returns decreases. To understand this better, let's look at an example:

Suppose you invest ₹1,00,000 in an FD at an 8.10% annual interest rate. After one year, you earn ₹8,349 as interest. If the inflation rate is 4%, the real return is calculated as follows:

Real Return = Interest Rate - Inflation Rate = 8.10% - 4% = 4.10%

This means that despite earning a fixed interest rate of 8.10%, your purchasing power has only increased by 4.10% due to an inflation hedge.

Benefits of Fixed Deposits

Fixed deposits are known for their low risk and stable returns. They offer a fixed interest rate for a specific period, from 7 days to 10 years. The longer you lock in your money, the higher the interest rate. Fixed deposits also provide the following benefits:

• Stability: Inflation-protected fixed deposits offer stable income and help your money retain its value during inflation.
• Tax benefits: Under Section 80C of the Income Tax Act, you can avail of tax benefits on FDs up to ₹1.5 lakh per year with Tax Saver FD. For regular FDs, senior citizens also enjoy an additional 0.5% higher interest rate, which is over and above the normal rate.
• Low risk: Deposit up to ₹5 lakh is protected under DICGC per depositor per account. Also, FDs are not market-linked products, meaning market volatility has zero impact on your returns.
• Liquidity options: FDs offer premature withdrawal facilities or allow you to take loans and overdraft against them, providing liquidity when needed.

Strategies for Enhancing FD Returns

To maximise your safe returns with inflation-protected fixed deposits, consider the following strategies:

Choose FDs that Offer Higher Interest Rates: Different banks and NBFCs offer varying interest rates on fixed deposits. Use an FD calculator to compare rates and choose the highest rate available to maximise your return on investment. Ujjivan Small Finance Bank offers high-interest Fixed Deposits tailored for your financial goals.

• Ladder your FDs: Instead of investing all your money in a single fixed deposit, consider laddering your investments by dividing the amount into multiple FDs with different maturity periods. This strategy provides regular access to funds and allows you to reinvest at higher interest rates as each FD matures.
• Utilise Senior Citizen Benefits: If you or your parents are senior citizens, take advantage of higher interest rates banks offer on fixed deposit accounts for senior citizens. This rate is 0.50% higher than standard rates.
• Submit Form 15G or 15H: If you fall under the non-taxable income category, submit Form 15G (for individuals below 60 years) or Form 15H (for individuals above 60 years) to your bank to avoid tax deduction at source (TDS) on your FD interest. This will help maximise your returns.
• Avoid Premature Withdrawals: Withdrawing your FD before its maturity date can result in penalties and limit your returns. Plan your finances carefully and commit to allowing your FDs to mature to avoid premature closure.
• Invest in tax-saving fixed deposits: Consider investing in tax-saving fixed deposits that offer competitive interest rates and provide tax benefits under Section 80C of the Income Tax Act. These fixed deposits have a lock-in period of five years and can help reduce your overall tax obligation.
• Regularly use an FD calculator: An FD calculator is valuable for managing your fixed deposit savings. It allows you to compare different schemes and interest rates offered by banks and NBFCs, helping you choose the most suitable option based on your financial goals and risk tolerance.

Investment Strategies for Inflationary Times

Adapting your investment plan to protect and grow your wealth is crucial in times of inflation. Consider the following strategies:

• Invest in short-term deposits: Short-term fixed deposits can be beneficial during inflationary periods. As these deposits mature, you can reinvest at possibly higher interest rates, keeping your investment aligned with current economic conditions.
• Diversify your portfolio: Diversification is crucial in reducing the impact of inflation on your investments. While fixed deposits provide stability, explore other asset classes such as stocks, real estate, and inflation-protected instruments. Diversifying your portfolio can help you earn higher returns and spread risk.
• Opt for high-income generating instruments: Research and compare various fixed deposit options in the market. Look for instruments that offer significant returns even during inflationary periods. Analyse past performance and current interest rates to choose the best fixed deposit alternatives.