| Though debt returns are nothing to write home, traditional small saving schemes still offer attractive options for the risk-averse investor.
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| Compared with the glamour of stocks and the impressive returns, they have offered in the past couple of years, investment avenues in the debt market have hardly been in focus. Can't blame them, though considering the fact that real return of interest that one earns on a majority of debt instruments may actually be in the negative.
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| Cruel as it may sound, the chief investment officer of a leading domestic mutual fund puts the plight of debt instruments in perspective. "Debt is dead," he said. While there is no doubt that investing in debt is not the hippest idea going around, it has to be noted that these instruments exist for a reason.
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| To put it simply, debt investing continues to be the safest option if you are a risk-averse investor. Here is a look at some of the best investment options available in the debt market depending on one's time frame and investment needs.
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| Short-term: Bank FDs still best bet
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| Despite the declining allure of bank fixed deposits, the fact remains that they still offer the most attractive returns for the short-term. These deposits offer rates around 5-6 per cent for the deposits from 45-days upto 180-days. In the recent months bank deposit rates have really shot up with liquidity in money market being tight.
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So while deposit rates have gone through the roof, liquid funds have suffered a serious setback. Liquid or cash fund returns have dwindled due to the turmoil in debt markets. Over the past three months, for instance, liquid fund returns have given an abysmal return of 1.2 per cent.
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INDICATIVE FIXED DEPOSITS RATES | |
Duration |
Interest
rates (%) | |
7-days to 14-days |
3.00 | |
15 days & upto 45 days |
4.00 | |
45 days & upto 179 days |
4.50 | |
180 days to less than 1 year |
5.00 | |
1 year to less than 3 years |
5.50 | |
3 years to less than 5 years |
5.75 | |
5 years and above |
6.25 | |
Source: State Bank of India |
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| Even though debt markets should stabilise and cash fund returns should soon get back to 4-4.5 per cent, experts advice investors to play safe and remain put with deposits for now. Even if an investor has to pay a one per cent penalty for early withdrawal, your money is safer in the bank lockers.
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| Medium-term: Float to gain
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| The adverse changes in the macro-economic indicators like rise in inflation or interest rates or changes in the global indicators generally affect the prices of the long-term maturity securities more than the short-term securities.
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| So income funds and gilt funds are still eminently avoidable. One good option is the fixed income plans (FMPs) of mutual funds. With FMPs you can escape the volatility in mutual funds.
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| The fixed maturity plan is an income scheme that allows saving only during the initial offer period. They provide an easy route to invest in different types of bonds that include money market instruments, corporate bonds and the government securities.
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| These funds typically act more like a close-ended scheme. On a one-year period these funds have managed an average return of 5.35 per cent. The fair predictability of the returns is the striking feature of these plans, which have made them popular.
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| FMPs come in different maturities ranging from quarterlies to five years. They combine the safety of fixed-deposits with the tax efficiency of mutual funds which makes them extremely popular.
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| According to a few investment advisers the fixed investment plan offered by the funds has taken the sheen away of the fixed deposit programs offered by the banks and blue-chip companies. that is because FMPs with 13 month maturity are great as they can avail of double indexation benefit which can substantially reduce the tax burden.
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| Investors could also consider taking an exposure to monthly income plans (MIPs), if they are willing to take a bit of equity exposure. MIPs usually have an exposure to equities in the range between 15-20 per cent on an average. With equity markets still offering potential for steady returns, MIPs can deliver better returns than plain vanilla debt funds. The average MIP returns for the past one "" year period are around 10 per cent.
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| For pure debt fund investors, floating rate funds offer the best option at present. These funds typically invest in floating rate securities or floaters as they are called in market terminology. The one year returns on the floating rate funds are 5.25-5.75 per cent. What edge do a floating rate bond have over the conventional fixed tenure bond?
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| The answer lies in the inverse price-yield relationship of bonds. Bond prices fall when interest rates rise, and vice-versa. Consider a five-year bond that pays a fixed rate of 4.75 per cent. What if the five-year rates rises to 5.25 per cent after you buy the bond? The price-yield relationship tells us that the bond price will fall to yield 5.25 per cent "" the yield that a new 5-year bond will fetch in the market.
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| The FRBs as the name suggests do not have a fixed coupon (interest rate) but have a variable coupon, which are based on the pre-determined benchmark and the coupons are adjusted periodically unlike the fixed income instruments carrying a fixed coupon. Any change in interest rate or inflationary pressures are likely to have the minimum impact on the floating rate funds.
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| Small saving schemes
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| These conventional instruments are at the services of risk averse investors for a longer term, while providing for decent returns. Public provident fund (PPF) is the most popular small saving scheme by far, with an offer of 8 per cent per annum the scheme has maturity of 15 years. It is a decent instrument for tax saving as PPF subscription entitles for deduction u/s 88 of the Income Tax Act.
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National saving certificates (NSC) is next in line with entitlement for tax exemption u/s 88 of the IT Act. The rate of interest is 8 per cent p.a. compounded half-yearly. The major drawback is liquidity as withdrawals are allowed only in specific instances like death of the holder, court order, or forfeiture by pledge.
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CONVENTIONAL FIXED INCOME OPTIONS | |
Options |
Lock-in-
period |
Returns
(%) |
Remarks | |
Public provident fund |
6 years* |
8 |
Maximum investment capped at Rs 70000 | |
National Savings certificate |
6 years |
8 |
Amount is fully taxable | |
Deposit Rates~ |
# |
5.25-6.25 |
Interest is taxable depending on income levels | |
RBI Savings Bonds |
6 years |
8 (Taxable) |
Premature withdrawal not allowed | |
Post Office Time Deposits |
6 months |
6.5 |
No premature closure before six months. Interest | |
(Rate for 2 years) |
is not paid if closed before expiry of one year. | |
* Withdrawal of only a part of the contribution
~ Deposit Rates relates to major banks
(Source: RBI Weekly Statistical Supplement)
# For term deposits of > 1 year maturity |
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| Kisan Vikas Patra is a doubling instrument for investors who have less tax concerns. The instruments double the returns in eight years and seven months. But it does not offer any tax benefit and the investor has to bare the tax liability. It benefits over other instruments as it offers liquidity after an initial period of two-years and six months.
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| Post office time deposits are available for period ranging from one year to five years. The range of rates offered varies from 6.25 per cent to 7.50 per cent. Post office monthly income plan offers monthly income with the return on investment of 8 per cent p.a. |
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