Imagine you have ₹10,00,000 in a Fixed Deposit (FD) earning an annual interest rate of 6%. At first glance, this seems like a reasonable return, but let’s see how inflation impacts the real value of your savings over three years.
We’ll assume the annual inflation rate is 7%. Here’s what happens over the next three years:
Year 1:
- Initial FD amount: ₹10,00,000
- Interest earned at 6%: ₹60,000
- Total amount at the end of Year 1: ₹10,60,000
- Inflation rate: 7%
- Purchasing power of ₹10,60,000 after 7% inflation: ₹9,90,200
Despite earning ₹60,000 in interest, the actual value of your money in terms of what you can buy has decreased to ₹9,90,200, meaning you’ve lost ₹9,800 in purchasing power.
Year 2:
- FD balance at the start of Year 2: ₹10,60,000
- Interest earned at 6% on ₹10,60,000: ₹63,600
- Total amount at the end of Year 2: ₹11,23,600
- Inflation rate: 7%
- Purchasing power of ₹11,23,600 after 7% inflation: ₹10,50,952
At the end of Year 2, your nominal balance is ₹11,23,600, but after factoring in inflation, its purchasing power is only ₹10,50,952. Inflation has eaten away another ₹72,648 of value. Even though the amount in your FD is growing, inflation keeps reducing its real value.
Year 3:
- FD balance at the start of Year 3: ₹11,23,600
- Interest earned at 6% on ₹11,23,600: ₹67,416
- Total amount at the end of Year 3: ₹11,91,016
- Inflation rate: 7%
- Purchasing power of ₹11,91,016 after 7% inflation: ₹11,12,645
By the end of Year 3, your nominal balance is ₹11,91,016. However, with a 7% inflation rate, the purchasing power of your money has dropped to ₹11,12,645. Over three years, inflation has eroded a total of ₹87,355 from your savings’ real value.
The Impact Over Time: What’s Really Happening?
- Nominal balance after 3 years: ₹11,91,016
- Purchasing power after 3 years: ₹11,12,645
- Inflation loss in purchasing power: ₹87,355
Even though you’ve earned ₹1,91,016 in nominal interest, inflation has reduced the purchasing power of your savings by ₹87,355, meaning the real value of your wealth has only grown to ₹11,12,645, not ₹11,91,016. Inflation essentially took a significant chunk of your savings, despite earning interest.
Why Relying Solely on FDs Isn’t Enough
If you’re only relying on Fixed Deposits for long-term savings, you’re at risk of losing out in the battle against inflation. Over time, inflation can erode the purchasing power of your wealth, and the interest earned in FDs may not be enough to keep up.
To beat inflation and grow your wealth, you need to look beyond Fixed Deposits. Consider higher-growth investments like stocks, real estate, or inflation-protected securities that can outpace inflation over the long term and protect your financial independence goals.
