Fixed deposits, fixed maturity plans and monthly income plans are offering high rates. But look at post-tax returns before taking a call.
Some banks increased rates steeply for certain maturities, depending primarily on their requirement for funds. SBI raised rates 150 basis points, from 4-5.5 per cent for 46-90 day deposits. Similarly, IDBI Bank raised rates for the same tenure by 100 basis points, from 4.5-5.5 per cent. Both HDFC Bank and ICICI Bank increased rates by 25-50 basis points.
| TRACK RECORD | |||
| Duration | Bank FD 1-year (SBI) | FMPs 1-year | MIPs 1-year |
| Returns (%) | 7.25 | 8 - 8.5 | 8 |
| Tax (%) | 30 | 10 | 10 |
| Post-tax Gains (%) | 5.07 | 7.2 - 7.65 | 7.2 |
| *Tax calculated without indexation | |||
For the risk-averse, it sounds like a good opportunity to get their money locked in bank fixed deposits. The main question, however, is should they do it now or wait for a further rate increase in the future?
The recent interest rise come against the backdrop of tight liquidity conditions. Going forward, one isn’t sure if the rates will continue to rise. No wonder financial planners are recommending short-term deposits because of a lack of clarity in the interest rate movement. “We are recommending fixed and recurring deposits to investors. But only for six months to a year,” says Kartik Jhaveri of Transcend Consulting.
But a higher deposit rate is not the only carrot for investors. One will also have to look at the post-tax returns. From this perspective, other products might be more tax-efficient. That is, SBI’s returns of 7.25 per cent would translate into less than five per cent for a tax payer in the highest bracket (30 per cent).
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“If you want a pure debt product, fixed maturity plans (FMPs) will earn a better post-tax return. For slightly aggressive individuals, monthly income plans (MIPs) can be even better,” says Anirudhh Hatwalne, a chartered accountant and financial planner.
At present, one-year FMPs are offering 8-8.5 per cent, according to market sources. The rates are higher than fixed deposits of similar tenure. But it is important to remember that both FMPs and MIPs have a risk element.
FMPs invest in corporate papers that could cause trouble in bad times. In October 2008, investors withdrew almost Rs 1 lakh crore from FMPs, when it was reported that many of these products were investing in risky papers.
Since then, the market regulatory body — the Securities and Exchange Board of India — has mandated that FMPs can no longer declare ‘indicative yields’ and ‘indicative returns’. In addition, they have to be listed at the stock exchanges, as well. As a result, unlike bank fixed deposits, these products lack liquidity.
MIPs, on the other hand, face equity risks. Since they invest between 75-95 per cent in debt, and five to 25 per cent in equities, a higher equity component can hurt in bad times. In the last one year, MIPs have returned eight per cent.
But both these products are more tax-efficient. In case of FMPs, if you have stayed invested for slightly over a year, there are double indexation benefits. For MIPs, if one chooses the growth option, the taxation after one year is 10 per cent with indexation and 20 per cent without indexation.
For those who are unsure about the interest rate movement, investing in parts and in short-term deposits are good options. But it requires constant monitoring and reinvestment, which could be a hassle. “Again, in three months, you would be looking at an avenue to put your money,” adds Hatwalne. To avoid this, one could park the lump sum in liquid funds and move the money to medium- or long-term debt funds.
For the pure debt investor looking to lock in money, financial planners recommend two-three year FMPs. Even MIPs can be a good bet because of the equity component. While five-year fixed deposits get tax benefits under Section 80C, the interest earning will be taxed.