Interest rates on bank deposits are trending downwards this year. As per data presented by the Reserve Bank of India today, the weighted average term deposit rate fell by 9 basis points in October, while it had declined just 7 basis points between February and September. This means that transmission of interest rate cuts from the RBI to the consumers is gaining pace, which will ultimately lead to lower interest rates on both bank deposits as well as retail loans.
Millions of Indians invest conservatively through fixed deposits and small savings schemes which guarantee fixed interest income. Fixed income instruments are especially useful to senior citizens. For them, drops in deposit rates can be damaging. Therefore, it’s a good idea to seek assured returns not just from bank deposits but from various alternatives as well. Having a diversified portfolio of fixed income instruments can guard conservative investors against drops in bank interest rates.
Let’s look at some alternatives to bank deposits to help better manage liquidity retirements as well as earn better post-tax returns on long-term debt investments.
Small Finance Bank FDs (with caution)
Latest data compiled by BankBazaar.com indicates that while public sector banks are offering anywhere between 5.5% to 6.7% on their FDs for regular depositors over varying terms, private sector banks’ FD rates are ranging marginally high at 6%-7.7%. So, government bank depositors stand to gain if they move to invest some of their deposits to a private bank after due diligence.
That being said, most small finance banks are offering 7%-9% on their FDs. While this may appear to be the most attractive deal, investors would be well-advised to limit their deposits in such banks to Rs. 1 lakh as that’s the coverage threshold offered by Deposit Insurance and Credit Guarantee Corporation (DICGC) in case any bank fails.
Short-term debt mutual funds
A good set of alternatives to your short-term FDs can be found in various debt mutual funds like liquid funds, short duration funds and ultra-short duration funds. Liquid funds invest in money market instruments and bonds and are considered low-risk investments whose returns could be better than FDs. Liquid funds also offer quick entry and exit making them highly liquid.
Short-duration funds, on the other hand, invest in debt instruments with maturity ranging between 1 to 3 years and can fetch higher returns than FDs of corresponding tenures. Ultra-short mutual funds invest in debt instruments with a maturity period of less than 1 year and have the potential to offer higher returns than even liquid funds. However, the risk involved is slightly higher too.
The other major benefit of investing in short-term funds is the fact that it’s more tax-efficient than FDs. While a 10% TDS is charged on FD interest income exceeding Rs. 10,000 for non-senior citizen depositors, there’s no TDS on debt funds. Also, FD interest income is taxed according to the applicable slab rate while debt fund capital gains are taxed according to the slab rate only when the holding period is less than 3 years. Capital gains for investments over 3 years are taxed at a 20% rate with indexation benefits.
As such, the possibility to earn more returns and better tax efficiency makes debt funds score over FDs. However, they are still slightly riskier than term deposits; so investors can use debt funds as a good diversifying tool to complement their FD investments.
Another viable alternative to FDs is corporate deposits which usually offer higher returns than bank FDs. The credit ratings of corporate deposits mainly determine the interest rate, so, it’s advisable that investors should go mainly for deposits carrying a high rating. That being said, the ones with the highest ratings usually offer lower interest rates than those with lower ratings, hence, investors should exercise caution and give preference to corporate deposits with AAA rating for assured returns. Also, corporate FDs are taxed the same way as bank FDs.
Small Savings Schemes
Risk-averse investors who are seeking higher returns than FDs should also consider various government-backed small savings schemes at their disposal that offer assured returns. Public Provident Fund, for example, is currently offering 7.9% interest and is regarded as one of the most tax-efficient instruments out there. However, PPF investments carry a lock-in of 15 years (partial withdrawal permissible only after completing 6 years of investments) so it’s an ideal tool for investors’ long-term financial goals. Also, one cannot invest more than Rs. 1.5 lakh in a year in PPF.
Those looking for a shorter investment tenure could also go for the National Savings Certificate which matures in 5 years. NSC is also offering an interest rate of 7.9% currently. However, do note that the maturity proceeds of NSC are taxable according to applicable slab rate making them less tax-efficient than PPF.
Risk-averse investors can also go for one-year, two-year, three-year or five-year postal deposits depending upon their liquidity requirements. These timed deposits are currently offering interest rates between 6.9%-7.7% which are compounded and credited on a quarterly basis. The interest income is taxed according to applicable slab rates.
Finally, there are two more small savings schemes that investors could consider if they meet their eligibility requirements. Investors who have reached the superannuation age of 60 years (or 55 years if the investor has taken voluntary retirement) can invest in Senior Citizens Savings Scheme for 5 years which can be extended by another block of 3 years. SCSS investments are currently offering 8.6%. Also, interest income is taxed as per applicable slab rate.
Investors who have daughters aged less than 10 years can also invest in Sukanya Samriddhi Yojana to build a corpus to secure their future. SSY is currently offering an interest rate of 8.4% and the proceeds are fully tax-exempted like PPF.
FDs are best used for managing liquidity needs and for earning moderate returns. But with a smart mix of other debt investments, you can earn higher returns without undue risks.
The writer is CEO, BankBazaar.com, India’s leading online marketplace for loans and credit cards.