Archive / Investment Adviser (Level 1) / Introduction to Personal Financial Planning

nism-series-xa-purchasing-power-risk-fixed-deposits-retirement[ INVESTMENT ADVISER (LEVEL 1) ]

What is the primary risk an investor faces when allocating 100% of a 25-year retirement accumulation portfolio to bank fixed deposits?

[ A ]Purchasing Power Risk (Inflation Risk) — the risk that after-tax fixed deposit interest will fail to beat inflation, eroding the real value of the retirement corpus.[ CORRECT ]

[ B ]Liquidity Risk — fixed deposits can never be broken or closed prior to maturity under banking laws.

[ C ]Exchange Rate Risk — bank deposits in India are legally redenominated into foreign currencies upon maturity.

[ D ]Default Risk — the commercial bank will automatically declare bankruptcy before retirement.

Takeaway

Over a 25-year retirement horizon, the dominant threat to an all-FD portfolio is Purchasing Power (Inflation) Risk — after-tax FD interest routinely fails to outpace inflation, so the real value of the corpus quietly erodes.

Derivation

Bank FD rates in India have historically run close to or below CPI inflation once taxed at the investor's slab rate, meaning the after-tax real return can be negative or negligible for long stretches. Compounded over 25 years, even a modest annual real-return shortfall of 1-2% compounds into a large loss of purchasing power — a corpus that looks nominally large at retirement may buy far less than projected. The exam tests this because FDs feel 'safe' (low default risk, capital protection) which lulls investors into ignoring the much larger, silent long-horizon risk: inflation eroding real spending power, which is precisely why equity/growth-asset exposure is recommended for long-dated goals.

Why the others fail

B — Liquidity Risk — fixed deposits can never be broken or closed prior to maturity under banking laws.

Bank FDs are among the most liquid instruments available — they can be prematurely broken with only a modest interest-rate penalty (typically 0.5-1%), not locked away permanently.

C — Exchange Rate Risk — bank deposits in India are legally redenominated into foreign currencies upon maturity.

Indian bank deposits are denominated and repaid strictly in Indian Rupees; there is no statutory mechanism that redenominates domestic FDs into foreign currency at maturity.

D — Default Risk — the commercial bank will automatically declare bankruptcy before retirement.

Domestic scheduled commercial banks are RBI-regulated and deposits are insured up to ₹5 lakh per depositor by DICGC, making automatic bankruptcy before maturity an unrealistic characterization.