With Sensex rising, EPFO offering 9.5% and RBI signaling rate hikes, you should focus on instruments according to goals.
Also, on Wednesday, the Employee Provident Fund Organisation (EPFO) hiked rates on the Employee Provident Fund (EPF) by 100 basis points — from 8.5 per cent earlier to 9.5 per cent for 2010-11.
Today, the Reserve Bank of India (RBI), in its mid-quarter Monetary Policy Review, signaled another round of rate hikes by increasing the repo and reverse repo rates by 25 and 50 basis points, respectively.
“If bank credit is not to become a constraint to growth, real rates need to move in the direction of encouraging bank deposits,” says RBI.
Provident fund
According to the laws, an employer deposits 24 per cent of an employee’s basic salary with EPFO annually. This includes employer and employee’s contributions of 12 per cent each.
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With the rate hike of 100 per cent for the financial year 2010-11, returns from EPF will be higher than bank deposits — the gap between EPF and Public Provident Fund (PPF) is going to be a whopping 150 basis points (PPF at eight per cent).
No wonder, financial planners feel increasing allocation towards EPF makes sense. “Given the tax-efficiency of the instrument, I will recommend that a person should increase their contribution as part of their debt allocation. But keep an eye on your goals, while allocating higher amounts to EPF because of lock-in constraints,” says Gaurav Mashruwala, a certified financial planner. This can specially be done by people in the lower salary bracket, or those whose basic is less than 40 per cent of their gross salary.
There is an option to increase the allocation, as well. An employee can increase his\her contribution voluntarily, up to 100 per cent of the basic to EPF. Of course, the incremental contribution will not be matched by employer. But the employer will deduct the additional amount and deposit it. This money goes into a separate fund called voluntary provident fund.
Also, if you have both EPF and PPF account, you can reduce the amount being contributed towards PPF and allocate it to EPF. But remember, this hike is for 2010-11 only. So, if the rates do not stay the same next year, you have an option to stop the additional contribution by asking your employer.
| GUIDELINES |
| * Immediate hike in deposit rates unlikely |
| * Invest in tranches in FDs of less than three years |
| * Opt for floating rate deposits |
| * Invest in short- and ultra short-term funds for less than six months |
| * With a six-month to one-year horizon, look at FMPs |
| * Increase your EPF contribution if you have a lower basic pay |
Deposit rates
Following RBI’s moves, there could be more hikes. “Expect more rate hikes. With the new interest rate on EPFO, banks will also offer competitive rates,” says Jitendra Balakrishnan, former deputy managing director, IDBI Bank.
Taking the central bank’s cues from the first quarter Monetary Policy Review on July 27, 40 banks had hiked interest rates on short- and medium-term fixed deposits by 150 basis points.
Financial planners say deposit rates will go up further, but one should not get locked into long-term deposits. “Don’t look at fixed deposits. Instead, invest in flexible deposits where the rate of interest keeps changing according to the market conditions,” says a senior State Bank of India executive.
Debt funds
Fund managers’ advise to wait before locking in your money, as they expect RBI to hike rates by another 100-150 basis points by year-end. A Balasubramanian, CEO, Birla SunLife Mutual Fund, says, “So, do not lock your money in long-tenure funds. Short-term bonds and income funds are good bet with three-six months’ horizon.”
Debt fund managers expect liquid and ultra short-term funds to yield 6.5 per cent in the next two-three months. Ultra short-term funds or liquid-plus funds invest in one-year bonds. These are slightly riskier than liquid funds and short-term debt funds.
“Ultra short-term category will do well. Shorter duration funds re-price quicker than longer ones and are good bet for a horizon of less than a year,” says Mahendra Jajoo, head-fixed income, Pramerica Mutual Fund.
Another option for an investor with a six-month to one year’s timeframe can be fixed maturity plans (FMPs). Fund managers recommend one-year FMPs, yielding 8 per cent at present. FMPs are likely to remain at the same level.
For those with over one year horizon, Gaurav Mashruwala, a certified financial planner says, “One may look at floater rate funds in the rising interest rate scenario.” Compared with floating rate funds, liquid and liquid funds are conservative and their portfolio maturity is low. A floating rate fund, therefore, can give higher returns in a rising interest rate scenario.