Lesson 2 of 2 · 7 min
Real returns: the sum almost nobody does
A 7% deposit taxed at 30% against 6% inflation is a real return of about minus 1%: the balance grows every year while what it buys quietly shrinks.
A return has to beat two things before it makes you better off: the tax you pay on it, and the inflation that erodes it. Most people check neither.
Your turn
A fixed deposit pays 7%. You are in the 30% tax bracket. What is your return after tax, in percent?
At 6% inflation, a 4.9% post-tax return is a real return of about minus 1%. Your balance is bigger and buys less than what you put in. Nothing has gone wrong — this is simply what the arithmetic gives.
Myth
“Fixed deposits are safe, so they cannot lose you money.”
Mostly false
They cannot lose you rupees, and that is a genuine and useful kind of safety. But they routinely lose you purchasing power after tax and inflation, which is a different risk that does not feel like one.
My father says he has never lost a rupee
KabirTara
Kabirasking
My father puts everything in fixed deposits and says he has never lost a rupee in his life. Is he wrong?
Taraexplaining
He is right about the rupees. The bank hands back every one of them. The question he is not asking is what those rupees buy on the day he gets them.
Kabirasking
But the balance goes up every year. How is that a loss?
Taraexplaining
Take the tax off the interest first, then set what is left against inflation. If prices climbed faster, the bigger balance buys less than the money he started with.
Kabirasking
That is a strange sort of loss. Nothing on the statement says it happened.
Taraexplaining
No statement shows it, which is why it goes unnoticed for decades. Rupee safety and purchasing-power safety are two different things, and a deposit only covers the first one.
Work it out yourself
Try your own numbers. Then try a lower tax bracket and see how much of the problem is tax rather than inflation.
Real Return Calculator (post-tax, post-inflation)Match them up
Four returns that are not the same return
Pick a term, then pick what it actually means.
Pick a term on the left.
Check yourself
1 / 3
Kabir asks
You set a 7% deposit against 6% inflation and conclude you are 1% ahead. What got skipped?
Done reading?
Saved in this browser — and finishes the course.