Falling Interest Rates Affecting Your Fixed Deposits?

By BankBazaar | October 25, 2016

Fixed Deposits Affected By Falling Interest Rates? Here Are Some Smart Alternatives!

The new RBI governor, Urjit Patel, announced a cut in the repo rate by 25 bps in April, this year. The new repo rate now stands at 6.25%. The Repo Rate is the rate at which the RBI lends to the other banks. The current repo rate is the lowest in the last six years and with the fall in inflation, there is the probability of another rate cut towards the end of the year.

While the rate cut is good news for borrowers opting for Home Loans and Auto Loans, it has an adverse effect on those looking for safe investment options. Bank deposits are popular investment options for risk-free returns. With the current rate cut, Fixed Deposits with any leading bank in the country would fetch returns between 7% -7.5%, which is extremely noncompetitive. It’s also tax-inefficient. When you factor 30% taxation on interest earnings, the actual return on a deposit earning 7% falls to 4.9%.

Other savings instruments which are risk-free and offer higher returns include National Savings Certificate, Public Provident Fund, post office deposits and other saving schemes, but these have a longer lock-in period, thus lacking liquidity.

Fixed Deposits with banks are usually preferred over these forms of investment, as they have a fixed tenure and allow withdrawal of cash prematurely after a portion of interest is reduced as penalty. Senior citizens especially, and retired investors trust Fixed Deposits because of predictable returns.

Additional Reading: Everything You Need To Know About Fixed Deposits

So where should you invest?

With the falling interest rate, Debt Mutual Funds are a good tax-efficient alternative, which happens to benefit from the current financial situation. These funds offer better returns than bank FDs and are as liquid as them. With a lower interest rate regime, Debt Mutual Funds qualify as an effective investment instrument for the ones open to some amount of risk.

Debt Mutual Funds come with a huge range of opportunities with different investment tenures. Debt Funds typically invest in fixed income securities such as corporate bonds, government securities, and other such instruments. Debt funds that invest in longer maturity papers have seen double-digit returns in the recent past.

Here are some of the debt funds, we suggest you consider over bank deposits.

  • Liquid funds: You can invest in these funds for a duration as short as overnight. There is no exit load and redemption is easy.
  • Ultra short-term funds: If you wish to invest for a period of about six months to one year, these funds are a great option.
  • Short-term debt funds: These funds invest in various corporate bonds certificate of deposit and commercial papers and they can also hold short-term government securities. Since the rate cut cycle is about to end, we suggest investment in short-term debt funds over a period of two to three years.
  • Dynamic bond funds: These funds are invested in a mix of government securities and corporate papers. As these funds are actively managed, investors can benefit from changing interest rate. Dynamic Bond Funds, which invest in varying maturity papers, are considered are a perfect substitute to the bank FDs in the current scenario.
  • Income Funds: These funds earn interest through primary investment in various corporate bonds and capital appreciation by selling them at the time of maturity. Investors looking for stable returns in the long run can look at investing in these funds.

Check This: Why Debt Mutual Funds Are Better Than Fixed Deposits

Apart from factors such as falling interest rates, which are speculated to remain low in the near future, the post-tax returns associated with debt funds are higher in the long run when compared with bank Fixed Deposits.

If debt funds are held over a period of 36 months or more, the gains from such funds are subjected to long-term capital gains tax. The taxation is at 20.6% with indexation benefit.

In case of Bank FDs, the interest earned is added to the income of the individual and taxed as per his tax slab. Thus, with the repo rate cut and inflation in control, one should consider debt funds to meet their investment needs.

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