Why retirees prefer FDs – The Hindu

It is true post-tax returns on bank FDs are unlikely to beat inflation. But more important is the retirees’ fear of running out of money in old age. | Representational image
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Most adult children have an issue with parents’ investing in bank fixed deposits (FDs). The argument is bank deposits earn low post-tax returns and do not beat inflation. This is true. Yet, it may be optimal for retirees to invest in bank deposits. Now, we look at the behavioural reasons why deposits are staple investments for retirees.

Stability and satisfaction

More money is certainly better than some, whether it buys more happiness or not. But the source of money is important, especially for retirees. Most may be uncomfortable if generating more returns requires taking higher investment risk. The argument is based on a behavioural bias called loss aversion. Typically, losses hurt us more than gains can give us happiness of the same magnitude. That is, ₹10,000 loss is likely to be more painful than the happiness a ₹10,000 of gain can give. Empirical research shows working executives are likely to invest only when risking ₹10,000 can offer a potential gain of at least₹20,000. That is, they want a reward to risk ratio of at least 2:1. Retirees require an even higher ratio, nearly 4:1. Why?

Retirees typically depend on their passive income to meet post retirement living expenses. Therefore, an investment portfolio that not only has a high return potential but also high downside risk is not preferred. What if a significant part of portfolio value is lost due to market crash? What if they sell equity investments every year, and then run out of money in old age? Most retirees, therefore, prefer stable income portfolios. The satisfaction of receiving stable income is more dominating than having to worry about fluctuations on equity investments — earning higher returns but with high downside risk.

Conclusion

Investing is about risk and return. But behavioural biases can dominate the structure of an investment portfolio. It is true post-tax returns on bank FDs are unlikely to beat inflation. But more important is the retirees’ fear of running out of money in old age. This can happen for two reasons. One, investments decline in value on negative returns. And two, the retirees outlive life expectancy, referred to as the longevity risk. Retirees, therefore, adopt a simple rule to moderate (if not overcome) their fear: conserve capital and consume income. Any investment that fit this rule is naturally embraced. Bank fixed deposits do.

(The author offers training programmes for individuals to manage their personal investments)