The Outside View

Interest Rate On Your Bank FDs To Fall! Here Are Promising Alternatives...

05 August 2017

These are tough times for conservative investors investing in banks deposits. Interest rates are regularly falling and unlike before, other options such as corporate fixed deposits have become risky propositions.

Under such a scenario, it might be frustrating for many of you since your investments generate lower returns.

What should you do under such circumstance?

The simple answer is: invest sensibly and smartly.

Here's what we mean...

There's no need to overreact to all macroeconomic events and developments. Instead, plan your invests in a manner that can help you achieve your intended financial goals, and stay focused on the path while being mindful.

Your portfolio isn't expected to generate higher returns at all times. What it means is long-term return potential of your portfolio should be consistent with your financial goals, risk appetite, market conditions, and inflation level among others.

Therefore, you need not get anxious about the falling interest rates.

In the first place, lower interest rates don't always mean lower returns. All you got to do is device an astute investment strategy, so that you clock a decent real rate of return (also known as the inflation-adjusted return) which is even tax efficient. Thankfully, with lower retail inflation (measured by the Consumer Price Index), your bank FDs are yielding a positive real rate of return. But you also ought to make smart choices which are tax efficient. Lower inflation facilitates savings that can be invested efficiently.

Here are some promising investment avenues...

Debt and money market mutual funds

Presently, while allocating your investible surplus to debt mutual funds, taking dominant exposure towards the longer end of the yield curve would be imprudent. It can be perilous, since most of the rally has already been captured at the longer end of the yield curve and there isn't much steam left. A 25 basis points (bps) reduction by RBI was already factored in (after CPI inflation for June 2017 registered a historic low of 1.54%).

Preferably, invest vide dynamically managed bond funds (with an investment time horizon of 2-3 year) - it would be a prudent approach. You'll also be better-off if your hard-earned money is deployed in short-term debt funds; but ensure to give due importance to your investment time horizon along with diversification in your portfolio. Consider investing in short-term debt funds for an investment horizon of upto 2 years. If you have an investment horizon of 3 to 6 months, ultra-short term funds (also known as liquid plus funds) would be the most suitable. And for an extreme short-term time horizon (of less than 3 months), you would be better-off investing in liquid funds.

Don't forget that investing in debt funds is not risk-free. Hence, it is critical to select debt funds carefully.

Tax-free bonds

Likewise, tax-free bonds are a good long-term fixed income option, especially if you are in the highest tax bracket and able to subscribe to the bonds in the primary market (as and when they are offered). Currently, there are no tax-free bond available for subscription in the primary market, but as the financial year draws to a close, you may find quite a few. You can even buy and sell these bonds in the secondary market; however, liquidity can be an issue. If you choose to sell the bond before its maturity and if there are no buyers on the exchange, liquidity will be found wanting.

Corporate deposits

A few highly rated corporate deposits and bonds may also yield better returns than bank FDs. But make sure you study the company's financials before investing, as the risk of default can't be ignored. This will save you from the financial shocks.

Equity mutual funds

If you hold a high risk appetite and wish to address some of your long-term financial goals viz. children's future - their education and marriage needs - your retirement, among a many others and have an investment time horizon of at least 5 years, SIP in equity mutual funds can prove worthy owing to the benefit of rupee-cost averaging and power of compounding.

But don't get carried away by the exuberance; instead invest sensibly by carefully selecting mutual funds that have displayed consistent performance track record and are from mutual fund houses that follow strong investment processes and systems.

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While investing rebalancing the portfolio plays a pivotal role, so that you can successfully accomplish the financial goals you have envisioned.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader.

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