While receding interest rates bring joy to loan borrowers, it is a cue for conservative investors, who prefer Fixed Deposits for moderate returns with low risk, to look for alternative investment avenues.
Why do people prefer FDs?
FDs are fixed income investment instruments for tenures ranging between 7 days and 10 years. They have a fixed and assured rate of return through the investment tenure. They’re considered safe, especially when held with reputable banks. Bank deposits are also liquid instruments and can be redeemed instantly, though with an interest rate penalty.
Additionally, Fixed Deposits also come with an insured sum of up to Rs. 1 lakh (including principal and interest) to cover the investor’s risks in case the bank defaults on the deposit payment.
Not just that, banks also provide loans and Credit Cards against Fixed Deposits to meet urgent fund requirements of the investor.
Trend analysis of FD interest rates
The interest rate on bank deposits has lowered gradually in the last five years. From 9.25% p.a. in 2012-13, it has now gone down to about 6.25% p.a. – a reduction of 32.4%.
| Year | Interest Rate PA (%) |
| 2012-13 | 6.5- 9.25 |
| 2013-14 | 6.5- 9.0 |
| 2014-15 | 5.0- 9.0 |
| 2015-16 | 5.0- 8.25 |
| 2016-17 | 5.25- 7.0 |
| Prevailing Rate | 5.5- 6.25 |
Note: Rate for 7 days to 10 years for < Rs 1 Cr. data taken from SBI’s website as on 5th May 2017
Say an investor who falls in the 30% tax bracket invests in an FD at the prevailing interest rate of 6.25%. With the current cost inflation rate hovering around 3.5% to 4%, the investor would be at the risk of capital erosion. Suppose he invests Rs. 1 lakh for a year, he earns Rs. 6250 in interest, out of which he would pay Rs. 1875 as taxes. His absolute returns are Rs. 4375—or 4.37%, which is a few coats of paint above the inflation rate.
To avoid erosion of your invested capital, you must look at an alternative investment option to get better returns with little to no increase in investment risk.
Here are some options.
Liquid Funds
Investors looking for conservative returns and a low-risk haven for their money can opt for liquid Mutual Funds. Such funds invest in debt papers with a maturity of less than 91 days and they are typically low-risk. As per the CRISIL AMFI Liquid Fund Performance Index for March 2017, this fund category has provided a CAGR of 7.80% in the last 10 years, 8.53% in five, and 7.20% in one. You can invest with a minimum of Rs. 500 and redeem your liquid fund units without any exit loads.
Corporate Deposits
Deposits held with private or public sector companies are known as corporate deposits. Like bank deposits, corporate deposits are also fixed-income instruments, generating interest returns over the investment tenure. Often, corporate deposits offer a marginally higher rate of return than the prevalent returns on bank deposits. Senior citizens may earn an even higher rate of interest on these deposits. Corporate deposits need to be evaluated carefully, and the issuing company’s ability to repay your deposit with interest earned needs to be understood.
To help you assess the company’s credibility, credit research agencies assign ratings to corporate deposits. The higher the rating, the lower your risks. The ratings are typically expressed in letters. For example, an ‘AAA’ rating expresses the lowest level of risk, with the highest probability of your capital being repaid with the promised interest, while a ‘D’ rating may indicate high risks of default.
Monthly Income Plans
Monthly income plans are Mutual Fund schemes. Don’t be fooled by the name—they’re not a way to replace your monthly income. They are debt-oriented investment instruments which allocate a major portion (70-90%) of your corpus in debt securities and the rest in equity. Therefore MIPs offer high levels of capital safety flavoured with equity-linked returns. As per the CRISIL AMFI MIP Fund Performance Index for March 2017, MIP schemes have a CAGR of 9.89% over 10 years, 10.88% in five years, and 14.95% in one year. Remember that since there’s a degree of risk involved with MIPs, they should ideally be employed for the medium or long term for the best returns.
Remember that since there’s a degree of risk involved with MIPs, they should ideally be employed for the medium or long term for the best returns.
Capital Protection Fund (CPF)
The objective of a CPF fund is to keep your invested amount safe through investment in instruments like treasury bills, certificate of deposits, and bonds which allows fixed income on investment. It also invests a portion of the investment in the equity market. CPFs are close-ended funds, usually with a maturity span of one to three years. This fund is ideal for conservative investors targeting a tenure of up to three years. In the last three years, the annualised return of the top-rated five capital protection funds ranged around 10% to 12.5% p.a.
Other Alternatives
If you are looking at a relatively longer investment horizon, you can consider small saving schemes such as the Postal Savings Scheme, PPF, Kisan Vikas Patra, National Savings Scheme, etc. which will bring you returns between 7.2% and 8.4%.
Lastly, if you’re servicing long-term loan debts such as a Home Loan, you may be best served by allocating funds towards principal pre-payments. This would help you make the most of the prevailing low-interest rates and reduce your long-term interest outgo. This may be a more fruitful use of your money than putting it in a Fixed Deposit as of today.
(The writer is CEO, BankBazaar.com)