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

  • Income tax department notifies return forms for firms

    New Delhi, Aug 2 (IANS) The Central Board of Direct Taxes (CBDT) has notified tax returns forms for non-salaried class, including companies, partners in firms and individuals deriving their income from proprietary business or profession for 2015-16. "E-filing of ITR 3,4,7 has been enabled, and for ITR 5 and 6, it will be available shortly," the CBDT said in a statement earlier this week. These forms are used by non-salaried entities to file income tax returns. …

  • Rs.1,150 crore plan to build strategic petroleum reserves

    New Delhi, Aug 2 (IANS) To secure India's energy economy against supply and price fluctuations globally, an additional funding of over Rs.1,150 crore is being provided for the Indian Strategic Petroleum Reserves Ltd.(ISPRL). Through supplementary demands for grant presented to parliament earlier this week, union Finance Minister Arun Jaitley sought an allocation of Rs.1,153 crore for buying crude oil to fill the first strategic crude oil reserve being built at Visakhapatnam by ISPRL. India …

  • Soaring onion prices leave Delhiites in tears

    New Delhi, Aug 2 (IANS) The soaring price of onions seems to have hit hard everyone in Delhi, where the price has simply doubled in retail markets. "Sir, you can take a samosa for free but please don't ask for onion salad," Ramanand, who runs a roadside eatery in Jungpura in south Delhi, tells customers. Onion prices have indeed shot up in recent weeks, recording as much as a 50 percent surge in wholesale markets compared to the rates in early July, according to the Delhi Agricultural …

  • RBI likely to hold rates on Tuesday

    New Delhi, Aug 2 (IANS) The Reserve Bank of India (RBI) is expected to hold interest rates at its monetary policy review on Tuesday and is more likely to cut rates by the end of the year when there is more clarity on the monsoons. According to the Export-Import Bank of India, the rising trend in inflation seen over the last two months and the rainfall deficits are expected to weigh over the considerations of weak economic performance. Consumer price-indexed (CPI), or retail, inflation rose to …

  • Himachal's apple business juicy with bumper crop

    Shimla, Aug 2 (IANS) The apple business in Himachal Pradesh, one of India's major producers of the fruit, is heading to be juicy this season with the state eyeing a bumper production of 37.5 million boxes of 20 kg each, or 750,000 tonnes, horticulture experts say. This is fairly larger than the last year's production of around 2.9 crore boxes," the state's horticulture director, D.P. Bangalia, told IANS. He said the harvesting of the early apple varieties have begun and the fruit is heading …

  • Onion prices soar, to remain high till October

    New Delhi/Mumbai, Aug 2 (IANS) Unseasonal rains, lower production and resultant shortages have made the onion dearer again, with prices soaring. "The damage was compounded by high moisture content, change in seasonal cropping patterns due to soil conditions and other factors," a leading wholesale onion merchant in Navi Mumbai, Rajeev Maniar, told IANS. As a result, the bulb price has shot up 50-60 percent in wholesale and retail markets in states despite belated measures by the union …

  • Former teenage soldier hatches millions from Chinese egg futures

    A decade ago Zhang Xiongjie was a teenage infantryman patrolling China's bleak border with North Korea. Now he stays in swanky hotels and drives a Mercedes Benz CLS - a remarkable rags-to-riches journey achieved in part by dominating one of the most obscure corners of China's unruly financial markets: egg futures. The story of how he earned so much money, so fast - 600 million yuan ($96.63 million), he says, in 2014 - highlights the casino-like nature of China's nascent futures markets, and …

  • Hopes of rate cut, more rainy days to support equity markets

    Mumbai, Aug 2 (IANS) A positive bias is expected to rule the Indian equity markets in the coming week, with investors hoping for a rate cut by the apex bank, passage of key bills in parliament and more rainy days ahead, experts said on Sunday. "The most important trigger for the markets is the Reserve Bank of India's (RBI) monetary policy review. A cut in interest rates will restore investors' confidence and open the flood gates of funds," Devendra Nevgi, chief executive of ZyFin Advisors, …

DON'T MISS

MARKET MOVERS

  • Most Actives
    Most Actives
    NamePriceChange% Chg
    27.25+1.45+5.62%
    SPICEJET.BO
    21.900.000.00%
    SUZLON.BO
    151.20-1.60-1.05%
    IDFC6.BO
    302.50+11.55+3.97%
    ICICIBANK.BO
    26.70+4.45+20.00%
    ANDREWYU.BO
  • Price % Gainers
    Price % Gainers
    NamePriceChange% Chg
    35.40+5.90+20.00%
    PRANAVSP.BO
    26.70+4.45+20.00%
    ANDREWYU.BO
    27.00+4.50+20.00%
    MRSS.BO
    114.65+19.10+19.99%
    PUNJCOMMU.BO
    106.55+17.75+19.99%
    SAPPL.BO
  • Price % Losers
    Price % Losers
    NamePriceChange% Chg
    35.60-8.90-20.00%
    SKFL.BO
    51.65-10.25-16.56%
    WALLFORT.BO
    283.70-55.00-16.24%
    NUCLEUS.BO
    23.00-3.90-14.50%
    CAMEXLTD.BO
    39.20-6.25-13.75%
    BERLDRG.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.

Yahoo Cricket