Risks in Debt Instruments like FD, RD and Bonds

Do you think investment made in Fixed Deposits, Recurring Deposits and Bonds are really safe?  Of course, investing in Debt Instruments like FD, RD and Bonds are considered as safe.  It protects the Capital and gives you some assured returns.  Though these are safe in terms of protecting the Capital, there is an inflation risk associated with them.  If the rate of returns doesn't match or beat the inflation rate, there is no use in investing in Debts Funds/Instruments. 

What is Inflation?

Inflation is the price increase of the products and services year by year.  It is measured as rate.  For example, if the price of a product, say Television is Rs.35000/- today with the inflation rate of 8% every year it would cost you around Rs.51426/- after 5 years.

How does Inflation affect the returns of Debt Investments?

If you have Rs.35000/- (the cost of television) and invest in Fixed Deposit (FD) for 5 years with the interest rate of 6.85% p.a. (prevailing interest rate of SBI as on February 2019) compounded quarterly, at the maturity you would get around Rs.49155/-.  So it means there is no return you have actually earned from the investment.  If the inflation is more than the interest rate, say 10% you have to pay extra amount to buy the Television.  Here, after 5 years you need to pay Rs.2271/- extra which you need to pay from your pocket, a cost of not beating the inflation.  Debt instruments carry interest rate risk.

Alternative to FD, RD and Bonds

So you have to earn better returns that are more than the inflation rate and also want to protect the Capital.  Where to invest?  You can invest in Debts Mutual Funds.  Debts Mutual Funds are actively managed by Fund Managers who analyze the Inflation risks, the Economic condition and invest wisely to give you better returns than Fixed Deposits and Recurring Deposits.  You can also consider at least 20% or your investments in Equity.  Equity is the only asset class that beat the inflation continuously over the years and suitable for long term investments.

Note: Debt Mutual Funds are also associated with risks and it may or may not give you any assured returns.  Unlike FD, RD and Bonds, Debt Mutual Funds won’t assure you solid returns.  So it is advisable to select hybrid mutual funds.  Hybrid mutual funds invest in both equity and debt instruments.