Fixed deposit rates are falling,where to invest?

With demonetization, banks are flush with liquidity, and a few leading banks have cut interest rate on fixed deposits. One builder in Chennai is offering interest at 7.5 % for buying flats.

With the Reserve Bank of India monetary policy around the corner, interest rates could fall further. This will balance the market to a great extent if the U.S. Federal Reserve Board raises interest rates in America.

All these factors will not be of help to investors relying on fixed deposits to earn more. Based on the tax slab, the actual returns may be lower. One-year fixed deposits give 6.75 per cent interest. If you are in the 30% (without surcharge) tax bracket, your net return will be 4.75%. So, it will be lower than inflation. That means you are effectively losing money by keeping money in fixed deposits at that level.

What options do you have?

Mutual fund debt is the only option available to earn better returns. Although in India debt mutual funds are three times larger than equity funds, the number of people investing in them is low, due to lack of awareness.

In debt mutual funds, several options are available. For a period of less than six months, similar to savings bank accounts, investment can be done in liquid funds.

For over six months, you have ultra short-term funds and for 1-3 years you can invest in short-term funds. If it’s a longer period, you can invest in government securities. Depending on the market condition, you can mix and match the debt investments. If you wish to have a dynamic mix of short-term funds and government securities, you can go in for dynamic bond funds.

Mutual funds offer much variety compared to the plain vanilla fixed deposits that banks offer. Yet, due to lack of awareness, retail investors have not gone in for debt mutual funds.

Tax advantage:-

Mutual funds held beyond three years offer not only good returns, but also tax benefits. Fixed deposits, on the other hand, are taxed based on your tax slab, no matter what period the investment is held for. But if you stay invested for more than three years in a mutual fund, you can claim indexation benefits.

Let’s say you invested Rs 5 lakhs in 2013 in a short-term fund, and it earned a 9 % return. Your investment value today will be Rs 6.47 lakhs. For this, you can adjust Rs 1.47 lakh through indexation for inflation. Assume indexed cost is Rs 1 lakh, you need to pay tax for the Rs 47,000 at the rate of 20%, or Rs 9,400.

If, on the other hand, you had invested in fixed deposits for the same return, your tax liability would have been Rs 44,100 for individuals in the 30 % tax bracket (see table for actual returns of different debt products over a 3-0 year period).

Risk factor:-

Most mutual funds invest in government securities, company deposits with AAA to  A- rating, depending on their mandate. Based on the return that you want and the risk you are willing to take, you can select the appropriate mutual fund to earn better returns than parking your money in plain fixed deposits.

Suresh Parthasarathy is the founder of myassetsconsolidation.com. He is a SEBI-registered investment advisor.