It is important to note that investments like bank FDs, RDs and others have zero risk. But can investments in FDs and RDs help you beat inflation?
Stock market investments are lucrative. But investment in stocks and equity-related investment tools attaches risk. It has been observed that stock market investment yields a better return than conventional methods of savings. However, it is important to note that investments like bank FDs, RDs and others have zero risk. But can investments in FDs and RDs help you beat inflation? The answer is clearly NO. There are many stocks that pay a higher dividend than what banks offer on FDs. Let’s take a quick look at which is the better investment option — Stock Dividend or Bank FDs:
Dividend-yielding stocks belong to the equity asset class, which has ownership in businesses whereas bonds and fixed deposits belong to fixed income which is lending money. Fixed deposits generate only interest income whereas bonds pay interest and can also generate capital gain if sold before maturity.
Bonds issued by a sovereign are considered risk-free only if held till maturity, if liquidated in the secondary market it may generate gain or loss as its price in the secondary market is derived from the interest rate movement. Bonds of private organizations carry default risk in case the organization is not able to repay the interest or principal or both. Along with that, they do carry liquidity risk if there are no buyers in the secondary market.
According to Pawan Parakh – Director & Portfolio Manager, Renaissance Investment Managers – fixed deposits and bonds are popular and form the biggest part of average household financial savings due to two main characteristics viz assured and predictable.
Fixed deposits of state-owned banks and large private banks are considered safe due to the public belief that they always honor the payments and in case of a monetary crisis the government will support large banks and they are covered under deposit insurance.
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“One knows the maturity amount and/or regular payouts. Though the interest rates over the year have moved downwards, the amount invested has been increasing, giving a sense of false financial security as the returns from bonds and fixed deposits have mostly not beaten the average inflation rate and post-tax, they have delivered negative real returns. The biggest advantage in the case of bonds is it limits the downside in a portfolio and gives predictable cashflows and in the case of bank fixed deposits the single largest advantage is liquidity, one can cash it at the shortest notice,” Parakh said.
Consistent dividend-paying stocks usually reflect that they are quality companies with high sustainable cash flows, stable financial and operational structures. Also, there are periodic returns in the form of dividend in addition to price appreciation.
“Good dividend-paying stocks tend to have lower volatility, especially during bear markets. Such stock prices do rise over time, but they do fluctuate in between, volatility in prices is a natural characteristic of the equity asset class. So, there is little or no predictability. While putting money in bonds or deposits, we know the investment duration as it is by part of them but while buying stocks there is no time duration attached to it. This creates anxiety during volatile times as the period is not defined,” he added.
So, dividend yield stocks do not fare well in terms of price and return fluctuation, but they do manage to outperform the inflation rate which is important for converting savings into wealth. Dividends paid by the company are also not fixed like the interest rate on bonds and deposits. They also do fluctuate and so the cash flows are less predictable. There is comfort in putting money in bonds and deposits as there is a lot of predictability, but they do very well in boosting the purchasing power of the money due to their ability to give higher returns compared to inflation.
When you distribute the money in both categories you end up having a sweet spot of reliability and higher real returns. So instead of debating apples or oranges, one should look at making a fruit platter. Both are wonderful avenues of stability and growth, provided you have the right mix of both in line with your investment duration.
Investing is simple but not easy. It is easy to get high dividend-paying stocks, bonds, or deposits but can lead to catastrophic investment decisions if done without proper research.
