Interest rates remained at an all-time low in 2021. Most of the popular small savings schemes such as Public Provident Fund (PPF), Senior Citizen Savings Scheme (SCSS), National Savings Certificate (NSC) and post office deposits saw rates go down by about 40 basis points to more than a percentage point between January and November 2021. One basis point is a hundredth of a percentage point.
Falling interest rates of small savings schemes rates have hit the money goals of people across the board. While senior citizens have been the most affected as they commonly invest in small savings schemes for regular income, other medium-to-long-term investors have also been hit.
How Falling Rates Affect Investors, Especially Senior Citizens
Small savings schemes are popular investment options and falling rates can affect the goals of investors. “The consistent decline in small savings rates means the target set a few years ago may not be within reach now,” says Adhil Shetty, CEO, Bankbazaar.com.
Even for long-term investment, small savings schemes are part of the debt portion of the portfolio. In fact, the interest rates of long-term investments such as PPF have fallen by as much as 1.5 per cent in the last five years. For instance, if you opened a PPF account in 2015 for 20 years, where you invest Rs 1 lakh every year. Considering the drop in interest rates over the years, from 8.7 per cent to 7.1 per cent per annum (provided it stays at this level), you would end up with a corpus of Rs 44.8 lakh as opposed to Rs 53.7 lakh.
A segment that will get majorly hit is the senior citizens. “People, primarily the senior citizens, who are solely dependent on the interest income from small savings schemes or fixed deposits, are bearing the brunt of the ‘falling interest rates scenario. Purchasing power is declining as post-tax interest income is slowly failing to beat inflation,” says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.
As the income from savings decreases reduced the purchasing power, senior citizens may be forced to sacrifice their standards of living. To cope up with the needs, they may eventually dig into their savings, which means the corpus may die down sooner.
Suppose you spend Rs 100 to buy something today, it will cost you, say, Rs 106 next year (assuming 6 per cent inflation). But if you invest Rs 100 in a fixed deposit, you may get Rs 105.50 (pre-tax) next year (at an interest rate of 5.5 per cent) or Rs 104.40 (post-tax if you’re in the 20 per cent tax bracket). You will fall short of Rs 1.60, which you may withdraw from your existing capital to maintain your standard of living. “Thus, it boils down to three options – either you compromise on the standard of living which is practically difficult after initial years or you eat up your capital faster which will lead towards a grave situation down the line or you look for alternatives by taking calculated investment risks,” says Sen.
What Should You Do?
“Small savings are still a viable investment to park a portion of your investments. However, to build a good corpus, you must invest in instruments that can provide inflation-proof returns, such as mutual funds,” says Shetty.
Just as capital preservation is a basic requirement in investing, the other objective is a capital appreciation to outrun inflation post-tax. “As practising financial planners, we believe that a proper investment plan is a must wherein asset allocation strategy is to be made as per the objective, risk profile, personal and macroeconomic scenarios. It would be wise to see that investors are not taking any undue investment risks with the aim of chasing high returns on investments. The risk profile of the investor must be in sync with the risks associated with investments. Otherwise, there’s a risk of capital loss,” says Sen.
Hence, it is important to have at least a portion of one’s investments in equity. While those at the beginning of their career can have up to 100 per cent of their investments in equity and decrease their equity exposure as they near retirement, even senior citizens should invest a small portion of their retirement corpus in equity to negate the effect of fall in interest rates.
