Issues and virtue of investing in FDs

This article shows you the issues associated with fixed deposits to meet monthly expenses. We then discuss why fixed deposits are important to you, whether you are a retiree or a working individual.

Last week, we showed you why rental income from residential property may not be an optimal investment to meet your post-retirement expenses. In response to this article and based on the lead article in the Investment World last Sunday, couple of readers wanted to know if bank fixed-deposits can be considered for meeting post-retirement lifestyle expenses. Fixed deposits provide stable cash flows, but may not be helpful in meeting your post-retirement expenses!

In this article, we show why this is the case. That said, we explain why fixed deposits should be an important component of any individual's portfolio.

Fixed issues

If you are dependent on income from fixed deposits to meet your monthly living expenses, you should have 11 fixed deposits each year, ranging from one-month deposit to 11-month deposit. We have assumed you need the money on the first of every month to meet your expenses; monthly expenses for the first month will be held in cash.

And that is not all. After the one-month deposit expires, the two-month deposit becomes a one-month deposit and so on. So, you should invest in a new 11-month deposit every month. Such a fixed deposit portfolio is called a laddered portfolio. It has investments across various maturities. We hope you understand the hassle of having a laddered fixed deposit portfolio, you have to religiously invest in a new deposit every month.

There is another issue. Each time you renew the deposit, you are exposing yourself to the possibility of earning lower income, for interest rate can decline. Of course, you are allowing yourself to earn a higher income should interest rate move up.

But remember, you are unlikely to react the same way to gaining and losing your income. Suppose you typically earn Rs 15,000 as interest income every month. And because of rate change, suppose you earn Rs 16,500 in one month and Rs 13,500 in some other month. The pain you suffer from losing Rs 1,500 (Rs 15,000 less Rs 13,500) is likely to be more than the joy you derive from getting additional Rs 1,500!

Fixed virtue

That said, all individuals should invest in fixed deposit because it provides stable cash flows. Suppose you are a working executive wanting to set-up an education fund for your child. You should initially invest a large proportion in equity, if you are planning to hold the investment for more than 5 years. But you will risk not reaching your objective if you keep your equity investments till the time you need the money. Why?

The stock market could decline when you want to withdraw money from the portfolio. It is, hence, better if you reduce your equity investments periodically and place that money in bank fixed-deposits that mature at the time you wish to withdraw the money.

Suppose you set-up the education portfolio in 2012 to fund your child's education in 2022. Further suppose the portfolio initially has 70 per cent equity and 30 per cent fixed deposits. You can reduce equity in 2016 to 45 per cent and increase your fixed-deposit investments to 55 per cent. The fixed deposits that you invest in 2016 should be for a period of 6 years to mature in 2022. You can further increase your fixed deposit investments in 2020 to 80 per cent. This increases the stability of your cash flows at the time you need the money. If you are a retiree, you can create the same portfolio structure as above to meet costs of in-patient medical expenses such as surgery. This is especially useful if you have just retired and healthy and want a corpus to meet such expenses, if incurred beyond 70 years.

Fixed deposits provide stable cash flows and are, hence, an important part of any individual's portfolio.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. He can be reached at >

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