Earlier this year, the State Bank of India slashed its interest rate for deposits under Rs. 1 crore. The rate went from 4.00% -- where it had been for six years -- to 3.50%. Other banks are expected to lower their rates as well.
Interest rates have been trending downwards for the last three years, and yields from various fixed return instruments have lowered. Since mid-2014, the Reserve Bank of India has lowered the repo rate seven times without raising it once. For investors who prefer conservative forms of instruments such as fixed deposits and PPF, the lowering of the interest rates means poorer returns. Therefore, the question must be asked: what are their alternatives.
Let’s examine the market for instruments with fixed returns. What are the options offering best post-tax returns? What are smarter alternatives? What is the level of liquidity associated with these instruments? And most importantly, how safe are they? Let’s take a look.
Small Bank Deposits
While the major banks will lower their deposit rates in tandem with the RBI’s rate cuts, there will always be smaller banks who will offer higher interest rates to remain competitive. There are many small banks today that will offer deposit rates that are higher than the SBI’s offering by up to 3.5%, subject to terms and conditions. For example, DBS has advertised its savings account which provides returns of 7% on daily balance under Rs. 1 lakh, 6% on daily balance between Rs. 1 lakh and Rs. 10 lakh, and 5% on daily balance between Rs. 10 lakh and Rs. 1 crore. If you want to generate higher returns from a liquid instrument, you may be better served by holding your cash in such a high interest-generating savings account.
Liquid Mutual Funds
Some see liquid mutual funds as an alternative to savings accounts. These are schemes that invest your money in short term money market instruments such as treasury bills, commercial papers, and deposits of various kinds. Since these are instruments with very short maturity periods, they carry the lowest interest rate risks among all debt fund categories. Your liquid fund investment carries no exit load, and can be redeemed in less than 24 hours by adhering to the cut-off time. As per the CRISIL AMFI Liquid Fund Performance Index for June 2017, this fund category has provided a CAGR of 6.83% in the preceding one year, 7.88% in the preceding three years, 8.37% in five, and 7.76% in ten. Liquid funds are also useful for temporarily parking your money while you make up your mind about where you finally want to invest it.
Whenever bank fixed deposit rates fall, corporate deposits start becoming more attractive to investors. These are deposits provided by public and private sector companies with tenures typically between 1 to 5 years. They typically provide returns that are marginally higher than bank deposits, with further increments for senior citizens. Before you invest in corporate deposits, have a look at its credit rating. Deposits with an AAA or AA rating appear most trustworthy and most likely to repay your capital with interest. Companies with lower ratings present higher risks of default, even if they may promise higher returns. Since these are long-term deposits, liquidity may be an issue with them.
Debt Mutual Funds
There are a variety of debt mutual funds in the market, varying from short term funds to long term ones, to dynamic funds that straddle the divide. These schemes invest in a mix of fixed income securities such as government bonds, corporate deposits, non-convertible debentures, fixed deposits, money market instruments, etc. Debt funds aren’t free from volatility and carry interest rate and credit risks. You can consider using SIPs to average out these risks and achieve the best possible returns. As a category, debt funds have outperformed small savings schemes and bank deposit returns. As per the CRISIL AMFI Debt Fund Performance Index for June 2017, the category has a CAGR of 10.14% for the preceding year, 9.59% for three years, 9.04% for five, and 8.59% for 10 years. Debt funds can be bought and redeemed at any point, easily. Check for exit loads before redemption. Debt funds attract Capital Gains tax. Short Term Capital Gains tax is paid as per the investor’s tax slab for investments redeemed within a tenure of three years, while a Long Term Capitals Gains tax with indexation benefit is paid for investments redeemed after three years.
Monthly Income Plans
MIPs are a variety of balanced mutual fund schemes that invest in a mix of debt and equity securities. These schemes are for conservative investors open to the idea of a small degree of exposure to equity. Typically, the equity exposure in these schemes ranges from 10 to 30%. This moderate risk means that MIPs can deliver returns higher than small savings schemes while their debt portfolio ensures relative safety from market volatility. As per the CRISIL AMFI MIP Fund Performance Index for June 2017, the category has a CAGR of 13.79% in the preceding year, 10.65% in three, 11.26% in five, and 9.80% in 10. It would be wise to invest in MIPs via SIPs. The taxation of MIP investments are similar to debt funds.
8% Government of India Bond
The 8% Government of India bond has been around since 2003. It is a six-year bond offering returns of 8% PA. All interest income earned through this bond is taxable as per slab. This is a government bond, and therefore it is considered the safest bond investment. Because of the long tenure, liquidity is a problem with such an investment, and therefore it should be used only to achieve long-term objectives. You can buy this bond by applying through trading accounts or nationalized banks with a minimum amount of Rs. 1000.
Post Office Schemes
The humble post office may not hold many attractions in the digital age. However, it continues to offer a host of reliable financial services. A five-year time deposit still earns 7.7% per annum – well above the rates offered by many banks. There are the Senior Citizen Savings Scheme and Sukanya Samriddhi Scheme that offer best-in-class returns of 8.4% per annum along with tax benefits under Section 80 C. The latter also offers EEE tax exemption, meaning your returns are tax-free.
Small Saving Schemes
There’s no beating some of these schemes. The humble Public Provident Fund still provides 7.8% PA, tax-free. If you’re a conservative investor planning to achieve a long-term goal, you can still pick the PPF which continues outperform its peers. The PPF also enjoys EEE tax exemption, so what you earn from your holdings is completely tax-free. Liquidity is a problem with PPF; therefore it is suited to long-term objectives rather than maintaining liquidity.
A recently-launched mobile payment bank offers its customers 7.25% on deposits. Customers can create new accounts using their cell numbers and also get a free personal accident cover of Rs. 1 lakh with their accounts.
The author is CEO, BankBazaar.com