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 http://www.fimmda.org) 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 deepakshenoy@gmail.com or@deepakshenoy.

Latest News

  • Jet Airways posts Q4 net profit at Rs.397 crore

    Mumbai, May 26 (IANS) Airline major Jet Airways on Thursday reported a standalone net profit of Rs.397.16 crore for the fourth quarter (Q4) of 2015-16. The airline had posted a net loss of Rs.1,728.99 ... …

  • Wall Street flat as stocks pause after recent rally
    Wall Street flat as stocks pause after recent rally

    U.S. stocks were little changed at the open on Thursday, taking a breather from their robust two-day run, as investors keenly await a speech from Fed Chair Janet Yellen on Friday. Comments from policymakers in recent days and upbeat U.S. economic data have raised expectations that the Federal Reserve could pull the trigger on a rate increase much sooner than previously thought. "The market will be looking for some direction from Yellen. …

  • Snapchat raises $1.81 billion in new funding round
    Snapchat raises $1.81 billion in new funding round

    REUTERS - Messaging app Snapchat Inc has raised $1.81 billion in an equity offering, indicating strong investor interest in the company despite concerns that it is struggling to attract advertisers. Snapchat ... …

  • Fed's Bullard says markets have better reading now on chances of rate  …

    Financial markets have a more appropriate reading now on the chances of a U.S. interest rate rise in June than before, St. Louis Federal Reserve President James Bullard said on Thursday. "I think they read the minutes correctly," Bullard told reporters after a speech in Singapore, referring to the minutes of the Fed's latest policy meeting in April. Global investors, many of whom had assumed the Federal Reserve was in no rush to raise interest rates, were jolted last week by the minutes which …

  • Gold up on lower dollar, U.S. rate rise views limit gains
    Gold up on lower dollar, U.S. rate rise views limit gains

    Gold edged higher on Thursday as the dollar's rally paused, moving away from a seven-week low hit in the previous session, though gains were limited by expectations that U.S. interest rates could rise as early as June. Spot gold rose 0.2 percent to $1,226.06 an ounce by 1226 GMT. "Gold has entered a phase of consolidation due to stronger views that the U.S. Fed will raise rates this summer," said Carlo Alberto de Casa, chief analyst at ActivTrades. …

  • Oil tops $50, lifts commodity stocks but Fed, China weigh
    Oil tops $50, lifts commodity stocks but Fed, China weigh

    Brent crude oil topped $50 a barrel for the first time in nearly seven months on Thursday, lifting commodity and energy-related shares in Europe and Asia, though worries about U.S. interest rates and signs of slowdown in China limited gains. Oil's rise took it to levels more than 80 percent above January's 12-year lows and was fuelled in part by a weaker dollar, which fell against the Japanese yen. European shares edged higher, led by the basic resources and oil and gas sectors. …

  • Equity markets surge to their highest levels in 2016

    Mumbai, May 26 (IANS) Positive global indices, along with fresh influx of foreign funds and a rise in crude oil prices lifted the Indian equity markets to their highest levels in 2016 on Thursday. Besides, ... …

  • Britain plans steel pensions overhaul to ease sale of Tata assets
    Britain plans steel pensions overhaul to ease sale of Tata assets

    Britain's government said on Thursday it had started discussions on overhauling the deficit-laden British Steel Pension Scheme, a major stumbling block for potential buyers of Tata Steel's UK assets. With serious offers now on the table for Tata Steel UK, Britain's government is racing against time to find a way to put the company's British pension fund on a sound footing to help facilitate a sale. The consultation is looking at separating the pension scheme from Tata Steel and reducing its …

DON'T MISS

  • The Rs 80,000 crore milk business is on a tear

    If you thought that all the action in business was concentrated around the e-commerce sector, you could not be more wrong. The unlikely category of milk and dairy products has been seeing some of the most ... …

  • Charged up

    Reliance Jio's battle with other cellular operators over spectrum usage charges is set to escalate. …

  • Cracking the Code

    HackerRank is helping companies recruit coding champions through online tests. …

  • Poor Prediction

    A Niti Aayog presentation says poverty in India could be wiped out by 2032. Is it possible? …

  • Missing in Action

    Villages adopted by Gandhis make little progress. …

  • The VillageEconomy

    Inside: Model villages 68 / How India failed its poor 76 …

  • Hardly Adarsh

    Saansad Adarsh Gram Yojana, PM's pet project, has the potential to kick-start the rural economy, but is going nowhere if we go by the results so far. …

MARKET MOVERS

  • Most Actives
    Most Actives
    NamePriceChange% Chg
    67.95-2.15-3.07%
    SPICEJET.BO
    15.35+0.30+1.99%
    SUZLON.BO
    104.15+6.90+7.10%
    ASHOKLEY.BO
    183.75+8.60+4.91%
    SBIN.BO
    98.80+4.25+4.49%
    IBREALEST.BO
  • Price % Gainers
    Price % Gainers
    NamePriceChange% Chg
    12.78+2.13+20.00%
    ALMONDZ.BO
    224.70+37.45+20.00%
    INDOTECH.BO
    319.80+53.30+20.00%
    SHREYAS.BO
    348.65+58.10+20.00%
    SHARDACROP.BO
    192.40+32.00+19.95%
    NILE.BO
  • Price % Losers
    Price % Losers
    NamePriceChange% Chg
    29.80-4.90-14.12%
    AAYUSH.BO
    23.90-3.75-13.56%
    EUROTEXIND.BO
    40.15-5.80-12.62%
    GAL.BO
    47.45-5.85-10.98%
    GENUSPOWER.BO
    83.05-9.80-10.55%
    GLOBALVECT.BO

QUOTES

 
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.
 
Sign-in to view quotes in your portfolios.