Interest rates are on a downward trajectory. The Reserve Bank of India (RBI) has cut the repo rate four times so far this year, a reduction of total 110 basis points (100 basis points is equal to one per cent) to 5.4 per cent. Majority of banks have also slashed their fixed deposit (FD) rates. State Bank of India (SBI), the biggest lender, has cut interest rates twice in the past one month. Currently, it is offering an interest of 6.50 per cent on one-year fixed deposit, while for higher tenure, say more than two years, it is 6.25 per cent for retail deposits of less than Rs 2 crore. For a person falling in the highest tax bracket of 30 per cent, the post tax return will come out to be around 4.38 per cent. Real interest rates (total return minus inflation) looks measly when we consider the rate of inflation. It can be financially stressful, especially for retirees, who depend on bank fixed deposits for regular income, as they will have to renew their fixed deposits at a lower rate. Here are some of the options that you can consider in the current scenario:
FD offered by small finance banks: FDs are among one of the most favoured investment instruments as they provide safety of capital and guaranteed returns. There are a few small finance banks that are offering interest rates higher than those in bigger banks in order to attract customers. For example, Jana Small Finance and Utkarsh Bank are offering an interest of 8.50 per cent on a one-year fixed deposit. One can go for these fixed deposits as these banks are regulated by RBI and are covered under the Deposit Insurance and Credit Guarantee Corporation of India. However, one should always remember that fixed deposit interest rates are taxable as per the slab rate
Post office schemes: Small savings schemes (SSS) are one of the most popular saving schemes and they generally offer interest rate higher than that of banks. There are long-term schemes such as public provident fund (PPF) that find favour with small investors. The interest rates on small saving schemes is pegged to the interest rates of government securities of similar maturity and is revised quarterly. It has been reduced in the recent quarter in line with the falling yield of government bonds. PPF is offering a return of 7.90 per cent. PPF is a good long-term option as not only the income as well as principal is guaranteed. It falls under exempt, exempt and exempt category, where the investment, the income as well as the maturity proceeds are tax-free. There are other SSS such as national savings certificate, which is currently offering an interest rate of 7.9 per cent and is also qualified for tax breaks under section 80-C.The fixed deposits offered under post office also offer higher interest rate than fixed deposits. For senior citizens, there is senior citizens savings scheme, which is currently offering an interest of 8.60 per cent.
Tax-free bonds: Government entities from time to time issue tax-free (no tax on interest) bonds which you can invest in. These bonds are long-term in nature and are generally issued for 10,15 or 20 years tenure. As these are issued by government entities the risks are lower. As the interest income is not taxable these can be a good option for those in the higher tax brackets intending to lock-in money for long-term. However, to invest in them, you will have to wait for the issue, which may not be open always. Also, in the secondary market where previous bonds are listed, liquidity is not good.
Arbitrage mutual fund: These are mutual funds that basically leverages the differential in price between cash and derivative markets. They are treated like equity funds for taxation purposes. "For short term horizon (less than three years), investors can also look to invest into arbitrage funds, which can generate superior post tax returns as they are subjected to equity taxation," says Rajesh Cheruvu, The Chief Investment Officer, Validus Wealth. As per
Value Research data, arbitrage funds have delivered a return of six per cent over the past one year ending September 17, 2019.
Debt mutual funds: Although, recent events have shaken the trust of investors in debt funds but one should not completely write off debt funds, believe experts, as they are tax efficient over the long-term. They provide indexation benefit which lowers the tax outgo. There are multiple categories of funds and investor should choose the one that suits their risk profile. "Debt funds are a good choice as long as investors do not focus only on portfolio yields and seek high credit quality portfolios. For short-term goals up to one year, investors can look at ultra short-term and low duration funds. For longer term goals, they can look at a combination of short term debt funds and medium term debt funds, along with some exposure to dynamic bond funds," says Vishal Dhawan, Founder and CEO, Plan Ahead Wealth Advisors. Investors should look at the portfolio of the debt fund before investing and should go for funds that invest in highly rated papers.
Non convertible debentures (NCDs): These are long-term bonds issued by companies. There are two types of NCDs - secured and unsecured. Investors should go for secured NCDs so that in case the company goes for bankruptcy, they are treated as secured financial creditors. However, experts believe that investors should be cautious while investing in NCDs specially in current scenario. "There are two prominent risk attached to NCDs. One is repayment of principal and interest and second is liquidity in the secondary market. I will suggest only AAA-rated securities with strong management such as TATA Capital, M&M Finance, L&T Finance, Bajaj Finance, HDFC and LIC housing Finance," says Vikram Dalal, MD, Synergee Capital Services. Investors should also be aware of risks associated with NCDs. "If the rating is downgraded for an NCD, the liquidity in a secondary bond market can be an issue. Size of an issue also matters, as the liquidity is dependent upon the floating stock," he adds. Most importatnly, instead of investing in one NCD, investors should spread their investment across different issues.