Bank deposits are losing their charm due to repeated rate cuts. Investors need to pick and choose.
Since November 2008, repeated rate cuts by the Reserve Bank of India (RBI) have improved the liquidity situation substantially. The result: banks have been regularly cutting both deposit and lending rates.
For the fixed deposit (FD) investor, however, that's bad news. Not so long ago, banks were offering yearly returns of 10 -11 per cent. Now these rates are down significantly.
This week, the country's largest bank, State Bank of India, announced further rate cuts by 25-50 basis points (to be implemented from May 18) - its third rate cut in the past 45 days. Now, their FDs between one year and less than two years will fetch only 7.25 per cent.
Many risk-averse investors look at FDs as their first choice – returns are lower, but the safety element is quite high. And, depending on their time horizon, there are a number of choices.
At the same time, there are competing instruments present for each time period that can be chosen in place of FDs. In the short period, FDs for a one-year period will compete with short-term funds. In case of a three-year time horizon, the competition is with non-convertible debentures and other bonds, which several companies and institutions issue to raise funds for their financial requirements. For an investor with a five-year time period, it is the small savings options like National Savings Certificates.
Here, we look at some of these options in the fixed income genre and their outlook.
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ONE-YEAR HORIZON
A lot of FDs are for a year's duration or periods like 350 days or 400 days. Many investors need to park funds they don't need for a year. Interest rates for this tenure have fallen in the past three months; as all banks have cut rates. These are expected to go down even more. So, when it comes to investing in a one-year time deposit, the investor has to ensure it is the highest rate available in the market. And not dither for long, as rates might dip more.
In terms of returns, banks are offering 6.5-7.75 per cent for a time period between a year and less than two years. Bank of Baroda, for example, has a 7 per cent rate for a 1-2 years time frame. SBI, after the recent cut (effective May 18) is giving 7.25 per cent. ICICI Bank offers 7.5 per cent for a year to 389-days and 7.75 per cent for a 390-day deposit.
These rates are quite good, if one compares these with returns from liquid schemes of mutual funds – they offer returns in the range of 5.5-7.5 per cent. But in the past one year, returns on short-term debt schemes have fluctuated.
THREE-YEAR HORIZON
An investor looking at a slightly longer time horizon would do well to consider the three-year rate. Banks offer better returns for this time period as they require long-term funds.
Going forward, there might be a small reduction in rates for this time period, too. The investor should look for the best deals. An option is to look at the special offerings provided by banks.
These deposits are for a specific period, perhaps not an exact round figure in terms of years or months, and the interest rate is a bit higher. The returns for such deposits are in the 7.25-8 per cent range. There are non convertible debentures and bonds that offer better returns. But FDs score over these other instruments on liquidity and flexibility.
At present, SBI has a 1,000-day deposit offering 7.75 per cent, while the 3-5 years rate is 7.5 per cent. ICICI Bank has a 990-day deposit for 8.25 per cent, while the 3-year tenure has an 8 per cent rate.
FIVE-YEAR HORIZON
While FDs are available for five years and above, investors need to remember there isn't much extra benefit available. It is especially meant for investors who want an assured return for the long term and laos gives tax benefits under Section 80C. The benchmark rate of return offered now is around 8 per cent.
In terms of actual offerings, the rates are nearly similar. HDFC Bank offers 7.75 per cent for a 5-8 year period. ICICI Bank offers 8.25 per cent for a 5-year deposit.
The writer is a certified financial planner