Where to invest now when Fixed Deposit rates are falling?
For most Indians, investing in Fixed Deposits (FDs) is like a ritual, which has been followed since ages.
The size of the Fixed Deposit pool in India, as on 31st March, 2020, was around Rs.142.5 lakh crore; this is much larger than any other investment instrument.
But can we continue investing in this traditional investment even today?
The current interest rate on a Bank FD has fallen sharply from~7% in 2019 to just about 5% p.a. After deducting tax, there is hardly any benefit left for the investor to cheer about.
What about the small saving schemes?
After continuous rate cuts by the RBI, the interest rates on small saving schemes have also been cut drastically for the April – June 2020 quarter. The table below shows that there is a drop of nearly 10% in the rates.
|Scheme Name||Old Rates (%)||New Rates (%)||
Interest Income (%) $
|Public Provident Fund (PPF)||7.90||7.10||7.10|
|National Saving Certificate (NSC)||7.60||6.80||4.76|
|Kisan Vikas Patra (KVP)||7.60||6.90||4.83|
|Sukanya Samridhi Account *||8.40||7.60||5.32|
|Senior citizen saving scheme *||8.60||7.40||5.18|
|Monthly income scheme||7.60||6.60||4.62|
*This scheme is not available for everyone. $ Tax rate of 30% is considered
Let us examine all other options
Most investors have confined themselves to these limited options for fixed income investments. This may be due to the lack of awareness about the availability of other fixed income instruments, which offer reasonable safety and can give slightly better returns than traditional fixed income instruments. The trade-off is between the risk-reward that the instruments offer.
Below are some fixed income instruments. We have excluded debt mutual funds from the list as these do not provide any fixed interest income and the return includes both interest and capital gains.
1. RBI Taxable Bonds
At a time when banks are providing an interest rate of around 5% on their FDs, RBI Bonds offer 7.15% p.a. interest on their taxable bonds. RBI Taxable Bonds now have a floating rate, wherein the interest rate will reset after every 6 months, on January 1 and July 1. The rate will be 0.35% higher than the NSC, which is currently at 6.8% p.a. The minimum investment required to invest in this RBI bond is Rs. 1000 and the maturity of the bond, i.e., the investment duration is 7 years. These bonds do not offer any prepayment option; even on the death of the investor, the nominee will receive the amount only on maturity.
2. Tax-Free Bonds
Tax-free bonds are issued by government companies and hence are considered to be safe as far as the principal is concerned. The interest income is exempt from tax whereas the gains from sale of these bonds are taxable. These bonds are tradable on the stock exchange, but they are not actively traded. This means transactions can only happen when buyers and sellers are available. The prices of such bonds have an inverse relationship with interest rates, i.e., when interest rates go up the price of the bond decreases and vice versa. Currently, there are no fresh issues of tax-free bonds.
3. Non-Convertible Debentures (NCD)
Private companies raise money by issuing Non-Convertible Debentures (NCD). The minimum duration of the issue is generally three years. The benefit of investing in NCDs is that the interest rates are not only higher than bank FDs but also higher than government bonds. Whenever one decides to invest, they should check the quality of the bond issued by the company, as these bonds carry a higher risk than government bonds. NCDs of big group companies can be preferred because the liability is also on the group company to safeguard the interest of the bond holders. Similar to tax-free bonds, NCDs are also tradable on the stock exchange and prices have an inverse relation with interest rates.
4. Company Fixed Deposit
When someone thinks of investing in Fixed Deposits, they usually think of bank deposits at first. Some investors may not realize that even private companies issue fixed deposits, just like banks. Company FDs typically provide a higher yield than that of bank FDs. However, they also have high risk. So, one must make sure that they are investing in trustworthy and high-quality company FDs. Credit rating agencies do provide ratings showcasing the risk levels of the company FD, but after the recent events of IL&FS and DHFL, it is difficult to completely rely on the ratings provided by them. So, one needs to always check the background of the promoter along with the ratings provided by the credit rating agencies. Investors can also go in for government promoted company FDs, which are safer than other company FDs.
The table below gives the approximate yield that one can earn from the fixed income instruments described above and bank FDs. For NCDs and Company FDs, only highly rated companies yields are taken into consideration.
|Particulars||Approximate Current Yield Available (%)||After-Tax yield (%)*|
|RBI Taxable Bond||7.15||5.01|
|Non-Convertible Debentures (NCD)||7.20||5.04|
|Company Fixed Deposit||7.20||5.04|
|SBI Bank 3Yr FD rate||5.30||3.71|
*Tax rate 30% is considered
The above table clarifies that by investing in fixed income instruments, apart from regular bank FDs and saving schemes, one can earn an extra return without compromising much on the risk factor. But even if the investors thinks that bank FDs are still the best viable option, then they should prefer FDs of scheduled and nationalized banks rather than co-operative banks.
Fixed income is a bigger market than even equity and it is also a very complex one. The complexities have increased after various credit default events and NPA issues in banks and NBFCs. Investors think that investment in equity is risky and that in fixed income instruments is safe. Yes, the risk in fixed income instruments is low as compared to that of equity investments but it is not zero.
While investing in fixed income, investors should ensure the following conditions are met:
- Protection of principal amount should be paramount consideration.
- What is the extra risk to earn the extra interest (reward) and is it worth it?
- Ensure the post-tax return is higher than inflation.
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