Why investing in bank FDs is a loser's game now | Economic Times

Buy, borrow, die. It is a strange way to describe a way of handling money. You’d have read about it if you have any interest in how rich people in the west manage their money. Of course, I doubt whether any such people read this column but the logic that drives the buy-borrow-die phenomena can affect your lives too so let’s take a look at what this is.In the past, rich people used to invest in stocks or fixed-income securities. The main goal of both was to generate a regular income through dividends and interest payments while keeping the capital intact and, in the case of stocks, to grow it a little. Of course, they had to pay taxes on this income, something no one likes to do. So things have changed in recent times. One change is that top-notch companies have more or less stopped paying dividends, or pay very little, which leaves sale of assets as the only way to extract the money you might need. The other is that interest on borrowings is very low. So now, what people have are asset types that just grow the capital without any payouts, either as dividends or as interest.So far, so good. However, here’s the part that sounds strange to you or me—when they need to generate money from these investments, then they borrow using the investments as collateral! This sounds weird to Indian ears but it sort of works. The reason is relatively high tax rates and very low interest rates. In a recent column by financial columnist Matt Levine, I came across the following illustration: Someone has $100 million and needs to generate $3 million from it. To do so through asset sales, they would need to sell $5 million worth, pay $2 million as tax and take the rest. Instead, what they do is to just borrow the $3 million with the investments as collateral. The interest on this is just about 1%. However, they have saved $2 million of tax and the entire amount is still earning a return. All in all, it may work out for many years. The ‘die’ in the title comes from the fact that in theory, this can be done perpetually. One thing is clear—these kind of grossly distorted financial tricks are possible only because of the huge amount of money at absurdly low interest rates that central banks of western countries have poured into the world economy. Essentially, what we have around the world is a very low interest rate regime, although the numbers vary. This has divided the world into two kinds of people: One, those who are borrowing; and two, those who are trying to earn money from debt, meaning through deposits and such.What does this mean? Here’s a simple and rather blunt answer: you need to get out of the second category. Perhaps not completely, but you need to drop the illusion that your money is doing anything worthwhile. When you lend to a bank (because that’s what a deposit is), you are ultimately competing with entities that can just create money or can source it from such entities. It’s a loser’s game. The world has always been divided into have and have nots. It’s just a surprise that in the financial world, the lender— especially the small lender—has now become a have not.Most of the time, your money is unable to keep pace even with inflation. Add the impact of taxation and it actively reduces in value with every year that goes by. That’s not an exaggeration. In real terms, fixed income has negative returns now. What’s worse, there is no end in sight.(The writer is CEO, Value Research)