Reconsider that Fixed Deposit

"Inflation rears its ugly head again, as RBI prepares to raise interest rates." You hear this all the time, and then wonder why you should bother. Over a year now, we, the retail public have been getting horrendously low deposit rates from banks. And if we got a bank offering us 9% deposit rates, the interest was taxed; and at the highest bracket, our real return was only 6.3%.

But this sounds incongruous with what the papers are telling us — that liquidity is tight, or that banks want money. If they are, why aren't we getting better deposit rates?

I have an emergency fund — 6 to 12 months of expenses — in a safe avenue, but I don't know if this emergency will happen in 1 month or after 5 years. My putting the money in a fixed deposit yields very little; plus, I end up paying tax on the interest. And if I use a longer term deposit, I get hit by a pre-closure penalty if I should have an emergency in the meantime.

So we've got three issues — we don't get the best interest rates, we pay taxes on the interest even if we reinvest it, and we fear pre-closure penalties. Is there a way around this, retaining the same safety as a fixed deposit?

Enter the debt mutual fund. Mutual funds are assumed to have equity exposure, but that is a fallacy; in India, more than 80% of mutual fund assets are in non-equity investments, mostly fixed income products. These invest in markets where money is traded, like call money markets, fixed income derivatives, bond markets; here, what you would get for a 1-year investment with the same bank is likely to be higher than what the bank offers for retail deposits.

For example, on Tuesday (18 Jan), an HDFC bank "Certificate of Deposit" (CD) was available at an interest of 9.74% for one year (You can see what was traded at The best HDFC Bank Deposit for a one year term is 8.25% - so the difference is substantial. You and I can't participate directly in these markets — plus, ticket sizes are 1 crore or more.  The way to get in is to invest through a debt mutual fund; in this case, "ultra short term" or "floating rate" funds. They buy these CDs, charge a management fee of the order of 0.5%, and give you the rest.

When rates go up, these funds rotate money often, investing in short term instruments (sometimes as short as one day), and take advantage of the rate increases as they happen.

But then, you ask, what about taxes? In mutual funds, you don't get taxed on any intermediate gains until you decide to sell. Keep the money in for two years? The fund may rack up gains, you don't pay tax. And if you decide to sell after a year, you get the additional benefit of long term capital gains tax, which I'll illustrate with an example.

Let's say you put in 500,000 into such a fund, exit after a year, and get a 9% return. That's Rs. 45,000 of gains. With long term capital gains, you get to "index" the gains; that means, they let you adjust the principal up for inflation. The 500,000 that you invested will be considered as 530,000 (assuming 6% is the announced inflation). Your taxable gain is only 15,000 — and the tax on that is, at 20% currently, just Rs. 3,000.

Compare that with making 45,000 in a fixed deposit — it will be added to your income and taxed; at the highest tax slab, you pay 30% of it, or Rs. 13,500 in taxes.

Now, consider the real world. It's hardly likely you would need the entire 500,000 you have stored for a rainy day. You might need Rs. 50,000 for an operation, or Rs. 100,000 to cover an emergency, but not the full amount. With a mutual fund, you can draw only a little bit at a time, without a penalty — and while certain fixed deposits do allow you early partial exits through a "sweep-in" facility, but most banks have started to charge a penalty for early exits.

Finally, funds are just as flexible. Nowadays you can buy and sell online, through the fund's website, your bank or your brokerage account. Money gets directly credited into your account, so it's just as hassle-free as a fixed deposit.

And of course, there are negatives. Today, we have a rising interest rate situation. When rates start to come down, floating rate funds are not the place to be.

We have a "flat" yield curve; at the shorter end (1 year or less to maturity) interest rates are very high — from 7.4% to 10%, with even 20 year debt sticking in the 8.5% to 10% ranges. If the curve "steepens", or short term debt becomes substantially cheaper compared to the longer term, then these floating rate products will likely give lower returns. But with RBI looking to hike up rates (RBI can only change short term rates at the moment) it's unlikely we see a steepening event that will hurt us — at least, in the one year term that people usually consider for fixed deposits.

Additionally, the risk in mutual funds is that they can choose to invest where they want; what if they buy dodgy instruments? These funds reveal their portfolio monthly, but you'll still need to check and see if they are buying rotten apples.

And the last risk is that rates aren't guaranteed, like you see with fixed deposits. They move according to the market prices. We love our sticker prices, and we love our guaranteed rates. But the risks seem benign; it's time to look at products that don't keep adding to our tax bill unnecessarily, and give us both flexibility and competitive returns.

Deepak Shenoy trades the Indian markets and writes at Capital Mind. He is a co-founder at MarketVision, a financial education site. You can reach him at or@deepakshenoy.

Latest News

  • Sensex, Nifty fall over 1 percent; U.S. presidential debate in focus
    Sensex, Nifty fall over 1 percent; U.S. presidential debate in focus

    REUTERS - Indian shares fell more than 1 percent on Monday, declining for a second straight session, as caution prevailed in global markets ahead of the U.S. presidential debate that will pit Donald Trump ... …

  • BOJ's Kuroda sees no big rise or fall in bond buying for now
    BOJ's Kuroda sees no big rise or fall in bond buying for now

    The pace at which the Bank of Japan buys bonds will depend on what is needed to achieve its yield curve target but no big increases or decreases were expected for now, Governor Haruhiko Kuroda said on Monday, dampening speculation that the BOJ was considering tapering asset purchases. Kuroda, in his first speech since the BOJ's decision last week to reform its radical stimulus programme, said the central bank stood ready to use every available tool to achieve its 2 percent inflation target. …

  • Gold slips on firm dollar; market focuses on U.S. debate outcome
    Gold slips on firm dollar; market focuses on U.S. debate outcome

    Gold prices edged lower on Monday as the dollar firmed, though the market is focused on the outcome of the U.S. presidential debate later in the day, that could see investors buying more of the metal as a hedge against financial uncertainty. Spot gold slipped 0.1 percent to $1,336 an ounce at 0719 GMT. U.S. gold futures slid 0.2 percent to $1,339.9 an ounce. …

  • S.Korea prosecutors seek arrest warrant for Lotte Group chairman

    South Korean prosecutors asked a court on Monday to approve an arrest warrant for the chairman of the Lotte Group conglomerate on suspicion of embezzlement and breach of trust, a prosecution source with direct knowledge of the matter said. The arrest warrant request comes after Lotte Chairman Shin Dong-bin, 61, was questioned by prosecutors in an investigation that has battered the country's fifth-largest family-run business group since it became public in June. …

  • German business morale shrugs off Brexit to hit 28-month high
    German business morale shrugs off Brexit to hit 28-month high

    German business morale rose far more than expected in September, reaching its highest level in more than two years, a survey showed on Monday, signalling that executives had brushed off concerns about Brexit that had weighed on their mood last month. "The German economy is expecting a golden autumn". "The Brexit shock has been digested for now," said Ifo economist Klaus Wohlrabe, adding that German executives appear to have overcome the "small amount of uncertainty" created by Britain's …

  • World stocks get the jitters as U.S. presidential debate looms
    World stocks get the jitters as U.S. presidential debate looms

    European and Asian shares retreated on Monday as investors waited to see how Donald Trump would fare in a U.S. presidential debate against Hillary Clinton, while oil prices firmed before an informal OPEC meeting. Half of America's likely voters will rely on the presidential debates to help them make their choice between Republican Trump and Democrat Clinton in the Nov. 8 election, according to a Reuters/Ipsos poll released on Monday. "A good performance from Mr. Trump could see market …

  • Oil steady as market awaits Algiers meeting; funds cut bullish bets
    Oil steady as market awaits Algiers meeting; funds cut bullish bets

    Oil held steady on Monday, as the world's largest producers gathered in Algeria to discuss ways to support the market, although scepticism about any deal being reached has prompted money managers to cut their bullish bets to a one-month low. Price fell by nearly 5 percent last week, dented by signs Saudi Arabia and Iran were making little progress in achieving a preliminary agreement to freeze production. Members of the Organization of the Petroleum Exporting Countries are meeting informally …

  • Brexit shock has been digested for now, Ifo economist says
    Brexit shock has been digested for now, Ifo economist says

    The shock over Britain's decision to quit the European Union has been overcome for now, Ifo economist Klaus Wohlrabe told Reuters on Monday after the institute's monthly survey showed business morale in ... …


  • Five Star Rating

    Crisil's revenue has seen an upswing under Ashu Suyash's innovation-led agenda. …

  • India, Pak Trade Up

    On August 15, Prime Minister Narendra Modi announced a shift in the country's strategy to tackle Pakistan by raising the issue of human rights violations in Balochistan and Pakistan-Occupied Kashmir or ... …

  • Setting the Agenda

    Zarin Daruwala aims to give a big push to retail banking at Standard Chartered. …

  • Back in the Saddle

    Mulye has managed to make all her stints at ICICI Group count. …

  • Stay Focused on Your Goals

    I have always been inherently passionate and ambitious about work and family, and perhaps it has a lot to do with my genes. Growing up, it was often hard to separate the family from the business of Lupin.... …

  • Renewing Big Blue

    How Vanitha Narayanan brought global tech major IBM back in the swing. …

  • Climbing New Heights

    Kola's business acumen and insights have made Kalaari Capital a force to be reckoned with. …


  • Most Actives
    Most Actives
    NamePriceChange% Chg
  • Price % Gainers
    Price % Gainers
    NamePriceChange% Chg
  • Price % Losers
    Price % Losers
    NamePriceChange% Chg


Recent Quotes
Symbol Price Change % Chg 
Your most recently viewed tickers will automatically show up here if you type a ticker in the "Enter symbol/company" at the bottom of this module.
You need to enable your browser cookies to view your most recent quotes.
to view quotes in your portfolios.