Fixed Deposit scheme vs Inflation

Fixed Deposit (FD) scheme is a saving scheme where the financial institution (FI) in which you deposit your savings, guarantees you of the principle and in addition, award you a generous return. Usually they will fixed a tenure of how long you should keep the money in order to claim the generous return. This period is referred to the 'holding period'. Various FI in Malaysia gives different return and it is always quoted in percentage per annum. For example, a 1 year tenure usually gives 3.2% return over principle, or a 12 months tenure gives 3.7% return over principle.
Most middle class and below prefers this type of scheme compared to other types because of its firm return rate over holding period.
What then are they missing? Is FD a good investment choice, especially this time around when the inflation rate is on the rise? FD rate is always tagged to the inflation rate of the country. When there is a continous rise in the core inflation rate, the Government will adjust upwards its Overnight Policy Rate (OPR), thus allowing the FI's to raise their Base Lending Rate (BLR). OPR is a loan interest rate of Banks which borrow money among the institutions. When their cost of borrowing increases they pass the cost to the retail loan consumers by increasing the BLR. Subsequently, all loan and saving interest will rise too. However, should the government maintains the OPR at the back of rising inflation, the banks also will maintain their BLR.
Currently, in Malaysia the Bank Negara (Central Bank) still have not notched up the OPR although the inflation rate is in the increasing trend. It has been reported that July's inflation rate was 7.9%, way too high from March's rate of 2.4%. So what does it mean and how it will affect the FD certificate holders?
For illustration, lets assume that you have saved RM50000 in a FD, for a 1 year tenure and its return rate is 3.7% a year. Can you compute the actual amount you will get at maturity?
Your answer could possibly be RM51850! An increase of RM 1850 over a year. You might feel happy and want to re-invest into the same FD again. STOP AND THINK AGAIN!!
Rather than focusing on its REAL RETURN you concentrated on the gross return of RM51850!!
The real return or the real value of your FD investment is and should be inflation-adjusted figure. So how do you count that?
Simple, just minus the inflation rate from the 3.7% of the FD return. Let us take 2.4% as the inflation rate. So, the inflation adjusted rate is now 1.3%. With a return of 1.3%, your FD return will be RM 50650. Hmm.....its getting lower, isint?
But try replacing the 2.4% with the July's inflation rate of 7.9%. The inflation-adjusted rate now is a negative 4.2%. The FD return now is only RM47900. Hmm.....very low right?
This inflation-adjusted rate is and far more accurate in determining the real value of FD return.
So, readers, there is one conclusion i would like to pen here, and that is if you want to choose any investment product that has interest bearing features, by all means you should go for the product which has the potential achieving return higher than the prevailing inflation rate.
Good Luck...!