Bank FDs are the most popular Investment avenues in India. RBI data shows that over Rs 71 lac crores are invested in Bank FDs as in 2013.
Most Investors are happy and feel secure with Guaranteed Returns. But what is that Guarantee? Is it Guarantee of Capital? Or Return?
An HDFC FD may offer you 9% but both Guarantee of interest and Principal are present. However if you invest in a Sahara FD offering 15% , you may get a Guarantee of interest but Guarantee of Capital? Well you decide!
The point that I am driving at is that Guaranteed Returns may not always give you the best bang for your buck. And mind you, Guarantee of Capital in a FD is upto a max of 1 lac, and that too in Nationalised Banks. Co-operative banks don’t come under this “Guarantee”. Returns from FD are likely to be substantially lower than those of an equivalent non-guaranteed investment option. Why?
Because there is a price for guarantee. If the bank needs to pay you 6% guaranteed interest, the bank needs to generate atleast 7.5-8% guaranteed income, which after deducting 1.5-2% of operating expenses (Salaries and other overheads), will generate 6% for you. Which means the bank will invest in a security like a GOI Bond which pays 7.8%-8.15% interest. Then why not invest in a GOI-bond ourselves? If guaranteed returns are the only consideration, then is it not better to invest in a GOI Bond rather than a Bank FD? Or if you trust the bank, why not invest in Equity Shares of the bank? An FD is after all a Debt portion of the Bank.
Investment in Bank Fixed deposits is for a fixed tenure. Once the tenure is complete, bank will encash the FD. So at the end, your money is safe. You get your principal invested back on completion of the tenure.
Now, look at this. Imagine you are driving on Mumbai-Pune Expressway which is designed for a speed of 80 km/hr. Would you still drive at a speed of 40 km/hr? If so, then why pay a heavy toll for a high speed road? The point I am trying to make is that if you are 25 years old and have an investment span of 30 years, why invest in a safe FD? You could grow your wealth faster in Equity. However, if you are on the wrong side of 50, it is wiser to stick to fixed income.
Now, look at the pathos- we invest in FDs for Safety and then scoot around to find out which FD pays higher interest! How much higher? May be 25-50 bps! Anything more and you could end up investing in a FD of a small , regional co-operative bank which may give interest 2% higher than SBI! And then, are we safe? Is the principal amount invested safe?
Bank FDs provide easy liquidity ie. Investors can encash the Bank FD much before the completion of tenure by simply paying premature penalty.
But what do we keep liquidity for? Unforseen events like a job loss, accident, hospitalisation etc. Right? How much liquidity do we need? 6 months’ expenses? Anything more and you are causing an opportunity loss. Except in an accident or emergency hospitalisation, if money is made available in 3 working days, I think, the liquidity of an investment is good. So, keep 6 months’ expenses in a bank FD and invest the rest of the money elsewhere. But where? That brings us to the last point.
Lack of suitable alternatives
“The classic Bank FD has no alternatives. We need not get tensed about the stock market ups and downs or about GDP numbers or Stability of Governments”. Is this the reason why most people invest in FDs ie. for lack of alternatives? Seems so, but incase you believe that there are no substitutes for Bank FDs, then think again!
Most people believe that Mutual Funds invest in Equities. In Equities, yes, but only equities? No! Not at all! Approximately 1/3rd of all mutual funds’ AUM (assets under management) are in Equities-yes, of the 6 lac Crores AUM of all Mutual Funds, roughly 2 lac Crores is all that is invested in Equities. So, where is the rest?
The rest is invested in what we call Fixed Income and Liquid Securities. These have 0% exposure to Equities, could have less volatility than Equities and could generate post-tax returns which are superior to equivalent Bank FDs! So, are they guaranteed? Well, SEBI does not permit MFs to assure any returns in any of their schemes.
Broadly, I suggest the following alternatives to the classic Bank FD:
|Tenure Bank FD Rate Alternative|
|Less than 3 months 3.5 – 4% Liquid Funds|
|3- 6 months 4 – 5% Ultrashort Bond Funds|
|6-12 months 5 – 6% Short Term Bond Funds|
|24-36 months 6 – 8% GILT Funds (G-sec Funds) and Income Funds|
|More than 36 months 8 – 9% GILT Funds (G-sec Funds) and Income Funds|
|Monthly Income 6 – 7.5% Monthly Income Plans(80% debt , 20% Equity)|
Please note that returns indicated for FDs are approximate and could vary from bank to bank and also, the above chart is for illustration purpose only and does not in any way guarantee any returns for the mentioned Mutual Funds.
Other aspects to be considered
Taxability: Bank FD interest is Taxable, whether TDS is deducted or not. If the bank deducts 10% TDS, it does not mean that the balance interest is tax-free! You need to add the gross interest to your income and deduct the TDS amount from your total tax payable. Hence, effectively, you need to pay tax as per your Tax-slab on the entire Bank FD interest!
Though there is no TDS in the above mutual funds, there is a Dividend Distribution Tax which could be 25% + Surcharge and Cess for Fixed Income Funds. If you are fond of Cumulative options, then there is a Long Term Capital Gain Tax of 20% after indexation or 10% without indexation, whichever is lower.
Cost on Equity: If you invest in Bank FD at 10%, the Bank would lend the same money at around 12%. The Industry would borrow it at 12% and thereby grow slower due to high interest costs. However, if the same industry could get money through the Equity Market, cost of Funds would be lower and growth, faster. And overall, the Economy (GDP) would grow much faster! And over the longer term, 5-year plus, Equity always outperforms most other investment avenues and is the best hedge against inflation.
Inflation also eats into the returns generated by Fixed deposits.
So, draw out the excess funds lying in low-return FDs- we can put the money to better use!