Riding on RD? Think again
Why equity SIPs are a better wealth-building tool than bank recurring deposits
By Research Desk | Jan 8, 2019
If you ask your grandparents, the best way to incrementally save for the long term, chances are they will recommend recurring deposits (RDs). An RD account is opened with a bank. It has a preset investment amount that you contribute monthly. The interest rate varies from time to time and bank to bank. For instance, a leading private-sector bank is currently offering 7 per cent interest on an RD of five years for individuals.
Does this investment option sound familiar? Systematic investments plans (SIPs) also work in a similar fashion. You agree to investing some amount periodically in an equity fund. Over the long term, you will have not only saved a reasonable amount but also likely grown it.
Fixed deposits (FDs) and RDs are traditional investment options. The traditional thinking was that if you have a lump sum to invest, you can do an FD; and if you want to save some amount every month, you can go for an RD. While there is nothing fundamentally wrong with them, they may not be the best way to build wealth. This is because they offer meagre returns, which when adjusted against inflation get further reduced or altogether nullified. Assume a situation when your RD offers you 7 per cent and the rate of inflation is 6 per cent. Effectively, you are earning just 1 per cent. Since RDs are also taxable, your net returns get further reduced.
On the other hand, SIPs in a good equity fund can generate much higher returns over the long term. For instance, the current (as of September 2018) five-year SIP returns of the multi-cap category of equity funds stand at 11.96 per cent. Five-year SIP returns from mid- and small-cap funds are at 12.87 and 13.38 per cent, respectively. Even large-cap funds, which tend to be more sluggish than other types of equity funds, have returned 11.24 per cent. Clearly, equity funds are a better wealth creator than RDs over the long term.
As the illustration shows, if you had invested Rs 10,000 monthly in an RD for five years at 7 per cent, at the end of five years, you will have accumulated Rs 7.20 lakh. But in the case of an SIP in a multi-cap fund, this amount would be Rs 7.98 lakh.
However, here is a word of caution. Equity funds tend to be volatile in the short term, unlike an RD. While an RD assures you returns, there is no surety of returns in equity funds. In the short term, they often result in capital losses. But if you are positive about the Indian economy and are willing to bear some volatility, in the long term, they turn out to be the best wealth builders.