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

  • LG V20: Super audio, great for multimedia consumption

    New Delhi, Jan 18 (IANS) After taking the industry by surprise with the world's first modular smartphone, the G5, it has mostly been a quiet period for LG before it launched another premium device, the V20, late in 2016 -- the world's first device with wide-angle camera lenses on both the front and back. For audiophiles, LG has collaborated with renowned European audio brand Bang & Olufsen (B&O) and the V20 comes with free B&O Play headsets (wow!). Here is what works for the V20. …

  • Havells India's Q3 net profit up 27.54%

    Mumbai, Jan 17 (IANS) Electrical equipment major Havells India on Tuesday reported a rise of 27.54 per cent in its standalone net profit for the quarter ended December 31, 2016. According to the company's ... …

  • Government puts on hold move to tax indirect transfers

    New Delhi, Jan 17 (IANS) In a measure of relief to foreign portfolio investors (FPIs), venture capital and private equity investors, the government on Tuesday said it is putting on hold its recent circular on taxation of indirect transfers. India's Central Board of Direct Taxes (CBDT) had on December 21 issued a circular applying indirect transfer provisions on FPIs whereby any profits made by funds with the underlying assets would have been taxed, including equities in India. Application of …

  • Chandrasekaran appointed Tata Motors Chairman

    Mumbai, Jan 17 (IANS) Tata Motors on Tuesday appointed Tata Sons' Executive Chairman-elect N. Chandrasekaran as an Additional Director and Chairman of its Board with immediate effect. "In accordance with Regulation 30 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, we would like to inform you that the Board of Directors have today appointed Natarajan Chandrasekaran as Additional Director and Chairman of the Board with immediate effect," the company informed the …

  • No impact of demonetisation on air passenger traffic: Minister

    New Delhi, Jan 17 (IANS) India's air passenger traffic growth has not been impacted by the central government's demonetisation drive, Civil Aviation Minister Ashok Gajapathi Raju asserted on Tuesday. "December ... …

  • Anchor investors oversubscribe for Reliance CPSE ETF

    Chennai, Jan 17 (IANS) Anchor investors of Reliance Mutual Fund Central Public Sector Enterprises Exchange Traded Fund (CPSE ETF) have bid for Rs 6,000 crore -- that is, four times their reserved quota, said industry sources. Some of the anchor investors for the fund are the State Bank of India (SBI), Axis Bank, Birla Mutual Fund, Nomura, Morgan Stanley and the Life Insurance Corporation of India (LIC). When contacted over phone, Neeraj Kumar Gupta, Secretary, Department of Investment and …

  • NIIT Technologies Q3 net falls 10% to Rs 62 crore

    New Delhi, Jan 17 (IANS) IT major NIIT Technologies on Monday posted a 10 per cent fall in its net profit for the third quarter ended December at Rs 62.4 crore, as compared to the Rs 69.4 crore net profit in the same quarter of the previous fiscal caused by seasonal softness in demand and currency volatility. NIIT Tech's consolidated revenues during the quarter in consideration grew two per cent to Rs 693.8 crore, from Rs 680.2 crore in the same quarter of 2015, the company said in a stock …

  • Domestic air passenger traffic up 23% in 2016

    New Delhi, Jan 17 (IANS) India's domestic air passenger traffic zoomed by 23.18 per cent in 2016 to 998.88 lakh, official data showed on Tuesday. "Passengers carried by domestic airlines in 2016 were ... …

DON'T MISS

MARKET MOVERS

  • Most Actives
    Most Actives
    NamePriceChange% Chg
    15.79+0.12+0.77%
    SUZLON.BO
    65.55+0.45+0.69%
    SPICEJET.BO
    62.60-1.45-2.26%
    JSWENERGY.BO
    38.00+1.05+2.84%
    ADANIPOWER.BO
    79.75+7.50+10.38%
    FAZE3Q.BO
  • Price % Gainers
    Price % Gainers
    NamePriceChange% Chg
    44.40+7.40+20.00%
    FMNL.BO
    448.50+72.55+19.30%
    TRIL.BO
    25.25+4.15+19.67%
    INDOTHAI.BO
    140.00+20.60+17.25%
    SEIL.BO
    85.00+12.50+17.24%
    ATHCON.BO
  • Price % Losers
    Price % Losers
    NamePriceChange% Chg
    13.54-1.65-10.86%
    SHRAJSYNQ.BO
    101.85-11.30-9.99%
    MNIL.BO
    9.20-1.02-9.98%
    PAWANSUT.BO
    21.20-1.80-7.83%
    DHINDIA.BO
    35.25-2.95-7.72%
    MODEX.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.