Are you investing in Fixed Deposits and renewing every year? There is an alternative and tax efficient too.

. Are you the one who is looking for safe havens and not the ones to take risk and lose capital.

The first option that comes to your mind is FD. There not so good news for investors in FD.

The Biggest PSU Bank SBI has reduced the interest rates in FDs recently and this has been followed by banks such as Punjab National Bank and others are following soon.

Why this is happening?

  • RBI has redefined liquidity and banks are now borrowing through term repo rates and the interest on this  is coming down.
  • The credit growth is not taking off. Companies are borrowing outside the banking system through commercial papers which are cheaper.
  • RBI is expected to reduce interest rates as the inflation is softening and this reduction may take place early 2015.
  • There is reinvestment risk, which means when you reinvest the FD or renew the FD, you are likely to get interest lower than what you are getting currently.

If you are the one who is renewing the FDs every year and staying invested in FDs at least for a period of 3 years, read on.

You are likely to get 6- 26% extra tax free return over FD returns.  See the summary table below  

There are options available which protect capital and can give you better tax efficient returns,

Preamble.

The market ie the sensex is at around 26 k and going by the valuation it is around 20 times PE and is much lower than the high valuations we had in 2007.

The prospects for the markets to go by in valuations are high due to the following reasons.

  1. The currently the earning of the sensex companies are at  1585 and is expected to grow at 15% CAGR and is projected at 1800 for FY 17.
  2. This being the case, at current valuations, market could be at least 20% higher and when the valuations catch up, we could see the market at higher value
  3. Also the inflation has peaked and is showing signs of slowing down.
  4. The GDP is projected to improve
  5. With the fiscal consolidation taking place, the interest rates are likely to come down.
  6. This will do good for debt funds, which has moderate duration which can benefit out of the lower yield curve.

Therefore considering the time frame and the requirement,

  1. The lumpsum can be invested in Debt funds, Like dual advantage funds, MIPs etc for which a minimum investment period of 3 years is recommended.
  2. This period is required a. to get indexation benefit and get better tax efficient return b. There is no exit load applicable beyond the 3 year period.
  3. These vehicles invest in both, debt and equity, debt being 75-80% and equity component being 20-25%.
  4. By doing this, generally capital is protected and there is a probability of getting higher returns.
  5. With the market outlook looking positive and debt market expected to do well with anticipated interest rate reduction,  the probability of getting higher returns are quite high.

I give below the year on year return if one had invested in reliane MIP, a debt fund.

Year of investment                         1 yr return           2 yr                         3 yr                         4 yr                              5 fyr

Oct 2009                                               11,615%               12,8%                    25.73                     41,54                 57.98

Oct 2010                                                1.06                     12.65                     19.22                     33.05

Oct 2011                                               2.2                        17.96                     40.55

Oct 2012                                               4.8                          25.64

Oct 2013                                               19

As you will see the return vary for a one year period but is farily stable for a 3 yearperiod and no capital loss has happen

The 5 years return on Rs 10000,  if invested in 2009 is 15,798 (57.98%) and . Using the indexation, which is adjusting the cost of purchase, 161.24 and hene no tax is applicable. If you had invested in FD at 9% interest, you would got, 13,150.

Consider three year return.s

2009 – The amount of Rs 10000 becomes, 12,573 and the cost using indexation is 12,216 and you pay tax on Rs 357 @ 20% . which is Rs 72. Total tax free return is 12,500. Compare this with 11,890

2010 –  11,920 Vs 11890

2011 –  14,055 is the return and cost is 11900 and you pay tax of 430 and net return is 13,625.

SUMMARY RETURN

tax free return
3yr 4 yr 5 yr
MIP FD %GAINS OVER FD MIP FD %GAINS OVER FD MIP FD %GAINS OVER FD
2009 12,501 11,890 6.11 14,154 12,520 16.34 15,798 13,150 26.48
2010 11,920 11,890 0.3 13,305 12,520 7.85
2011 13,625 11,890 17.35

Conclsuion

If you are renewing FDs year on year, you can consider these types of fund, which for a period of more than three years can offer capital protection and can offer good return in comparison to FDs in the long run.

Please do contact me for choosing the right vehicle for investment.

varadharajan

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2 thoughts on “Are you investing in Fixed Deposits and renewing every year? There is an alternative and tax efficient too.

    1. Thanks. However the latest post was on reducing interest rate. The articles are same, the contents are different. When you find time you can read the other one as well.

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