India markets open in 7 hours 9 minutes

Fixed return investments like FDs can’t beat inflation, but can they protect you during a financial crisis?

Amitava Chakrabarty
2008 subprime crisis, 2008 global financial crisis, financial planning, Term Insurance, Endowment Insurance, loan against insurance, fixed return instruments, fixed deposits, FDs, bank loan, Recurring Deposit, RD, Monthly Income Scheme, MIS, bonds, equities, equity mutual funds, MFs

Interest rates offered by banks on fixed deposits (FDs) hardly beat inflation, and when tax is deducted from the interest earned, returns on FDs fall below the rate of inflation. So, you would end up with lesser purchasing power if you invest in fixed income instruments like FD, Recurring Deposit (RD), Monthly Income Scheme (MIS), bonds, endowment insurance plans etc for a long term.

Financial planners, therefore, always ask people to avoid such fixed income instruments for long-term investments, and suggest to invest in equities, equity-oriented mutual funds (MFs), term insurance plans, among others.

The question is, despite inflation and tax inefficiency, why such investments are still very popular and thriving? Can fixed income instruments help you wade through a financial turmoil like that of 2008 global crisis?

In the 2008 subprime crisis, not only thousands of bank employees lost their jobs when Lehman Brothers went bankrupt, but apart from rattling the US markets, the cascading effect threw many other markets, economies and companies out of gear worldwide, resulting in a massive job loss.

The quantum of job loss in developed nations made the respective governments provide unemployment assistance to ensure their survival as planned investments in term insurance plans and equities or equity-related instruments proved useless in the down market.

Even the debt-related instruments borne the brunt as financial institutions and companies faltered in repayment due to high debt and low liquidity as people relied more on mortgage and EMIs to liverage their assets and income, making themselves as well as banks and companies near bankrupt.

Talking on the difficulties faced by people during the 2018 downturn, Greg Balian, Regional Director, Financial Planning, with US-based Northwestern Mutual Wealth Management Company described that many people were forced to sell their assets, because they couldn’t get loans as banks didn’t have enough money. Moreover, taking loans from banks are a difficult process and required submission of tax returns and many other financial documents to qualify for a loan. However, life insurance loans are straight forward. To take a loan from a insurance company against a whole life policy (endowment policy), the policyholder needs to fill a simple form and the loan amount would be sanctioned in a couple of days, provided the policy has acquired cash value (surrender value).

However, the scenario was quite different in India. Although many companies stopped increment, some even cut salaries and some went on to cut jobs taking advantage of the global crisis despite the fact that their own financial position were not so bad. Making the situation even worse for those who lost jobs, inflation jumped after salaries of government employees got doubled in that year.

Despite all the adversities, apart from stock markets, neither the Indian economy nor people suffered as much as those of other countries.

Although some economic factors like sound banking system and self sufficiency of the Indian economy worked in their favour, but some of the prevailing spending and investment habits of people helped them sustain without begging for help from the government.

First of all, at that time there was not so much craze for buying things on EMIs and traditionally Indian people avoid taking loans by putting things on mortgage, unless in a dire need of money. Such good spending habits reduced pressure on the banking system as adequate liquidity was maintained. Less or no burden of repaying loans and EMI installments kept expenses under check and provided some comfort to the people.

Another factor that helped people at that time was investments without proper financial planning. Although it sounds strange, but the habits of most Indians to put money in less risky and low-earning instruments actually proved beneficial at that time.

Although lack of financial planning is a detrimental for creation of long-term assets, but guaranteed low-earning instruments provided them much needed protection and liquidity at that juncture.

For example, without any planning, most people take endowment insurance policies that don’t provide adequate life cover, but they were able to either surrender those policies or take loans at lower interest rates against those policies at the time of crisis. The habit of investing in FDs also protected them from market crash and provided much-needed funds at the time of need. Another habit of Indians that proved beneficial was the tendency of buying gold and gold ornaments, which also helped them stay buoyant at the time of crisis as shining gold helped them raise money either selling the yellow metal or taking a loan against them.

While it is very important to make proper financial planning before investments to achieve long-term goals, but at the time a massive global financial crisis like that of 2008, some low-earning investments may actually help in staying afloat and not those financially planned instruments like term insurance or equity-related instruments.

So, keeping some money in low-earning secured instruments along with planned instruments may prove to be quite helpful during a wide-spread financial crisis, especially when people are increasingly relying on buying things on EMIs or loans.