How Inflation Affects Fixed Deposit?

Here is how FD interest rates are impacted by the inflation rates: 

1. Inflation drops the purchasing power of the FD interest rates 
2. Increase in inflation rates decreases the real value of the interest earned 

1. In terms of the goods and services that can be bought, the actual value of the interest rates 
2. Value of money gets affected by inflation over the time 

Example, as to how inflation affects the interest earned from FDs: 

For an investment of Rs.1 lakh, interest earned is 6.00% per annum for a tenure of three years. 

The inflation rate is 4.00% that decreases the purchasing power of the investment amount. 

The real return would be 6.00% minus 4.00%, which is 2.00%. 

Hence, the real value of investment of your investment has increased only by a margin of 2.00%. 

Impact of Inflation on FD Interest Rates 

Here are the details of inflation on FD interest rates: 

1. The effect of inflation on FD interest rate may vary depending on the FD tenor. The long-term deposits are susceptible to inflation, though it provides a high rate of interest. 
2. Purchasing power gets lowered due to inflation that impacts the FD interest rate and the real value of the deposit decreases significantly 

1. RBI drops the repo rate to combat the inflation 
2. To establish a link between inflation and loan or deposit interest rates, the interest rates of both lending and deposits are raised by the bank 

Note: Repo rate is the rate of interest charged by the Central Bank when commercial banks borrow funds. 

Inflation Effect on Investment Returns 

Here is the effect of inflation on investment returns: 

1. The rate of inflation lowers the FD returns when the taxes are subtracted from the interest earned 

1. Choosing short-term investment is beneficial as you can benefit from the constantly shifting interest rates as the FD rates are pre-determined 
2.  Inflation impacts are least for those who belongs to lower tax slab and selects short-term FD tenor 

Ways to Maximise Returns on Your FDs 

The following are the ways to increase the investment returns on your fixed deposits: 

1. Avoid withdrawing funds before maturity -  Premature withdrawal of FD amount is not recommended as withdrawing funds before maturity decreases your investment returns and also imposes 1.00% penalty (depending on bank policy). 

1. Open senior citizen FD account for high return - To maximise FD returns, you can invest money in your parents’ account if they do not come under taxable income, as the banks offer high interest rates for senior citizens. 
2. Submit Form 15G and 15H - To avoid tax deduction and maintain maximised returns on FD submit Form 15G and 15H in your fixed deposit account if your income comes under a taxable slab. For general categories submit 15H, while customers above 60 years of age should submit 15G to avoid tax deduction on your FD interest. 
3. Select annual taxation option -  To maximise your FD returns opt for annual taxation as the interest is calculated on a cumulative basis, which makes you earn more interest. As the FD interest is taxable, opt for those banks or financial institutions that deduct TDS annually. 
4. Renew FD account - To beat inflation and maximise your FD returns opt for short-term deposits and keep renewing it to earn maximum returns after every renewal. This also enables you to benefit from the revised interest rate and keeps you away from market fluctuations. 
5. Select cumulative FD - Cumulative FDs are those that offer interest at the end of the FD term after compounding the interest on a quarterly or yearly basis, unlike the non-cumulative FDs that pay out interest at a fixed interval as per your choice. It is advisable to select cumulative FD to earn the net interest income at the end of the term to earn increased FD returns. 

1. Calculate interest rate after comparing thoroughly - The interest rate offered by FD varies from one bank to another, hence, it is recommended to compare and research the interest rates offered by various banks before making an investment to maximise your returns. 

Investment Strategy During an Inflationary Period 

The following are the investment strategies that should be followed during inflationary period: 

1. Invest in short-term deposits - Investing in short-term deposits during inflationary period enables investors to achieve the benefits of higher interest rates by reassessing the investment strategy.  
2. Diversify the investment portfolio - To help mitigate the impact of high inflation and earn high returns, invest in multiple asset classes instead of only depending on FDs. Invest in other assets, such as real estate, equities, and inflation-protected securities to diversify the portfolio. 

1. Make investments in high-income generating instruments - Reasearch on various FDs and compare the FDs rates that offers high returns even during inflationary period. After thorough analysis, invest in high-income generating instruments to avoid losing money in inflation. 
2. Make investments in tax-saving instruments -  Consider investing in tax-efficient instruments such as tax-saving FDs and tax-free bonds, to mitigate the impact of taxes on investment as inflation can involve an individual in tax-brackets.