Sep 27, 2017 04:26 PM IST | Source:

Millennials! Don’t shun bank fixed deposits altogether

Possibility of earning quick money trading in stocks and the thrill of investing in a rising NAV mutual funds further make these investments attractive.

Falling interest rates on bank fixed deposits and rising stock markets make many investors switch to equity funds dumping bank fixed deposits. A lot of positive information about mutual funds makes many young individuals consider investing in them. Possibility of earning quick money trading in stocks, and the thrill of investing in a rising NAV mutual fund scheme further makes these investments attractive. No wonder the bank fixed deposits appear an old school thought. But before you write it off, ponder over a few facts.

Need of an emergency fund

Meet a financial advisor for a financial plan and the first action point remains – creation of emergency fund. Put simply, the financial planners ask their clients to create a corpus big enough to pay for one’s expenses for at least six months. The logic is if one loses his job, he should have some money on hand to fend for himself till he gets another job.

This money has to be kept in ‘safe’ investment avenues. One should be in a position to withdraw cash at a short notice. The two options that satisfy these two conditions, include bank fixed deposits and liquid funds.

“You can also consider a sweep in bank account, which keeps creating bank fixed deposits when there is excess cash and lets you withdraw it when you need it,” says Jitendra PS Solanki.

Short term goals

“There are many short term financial goals one has to save for. Bank fixed deposits come in handy in such cases,” says Joydeep Sen, a Mumbai based financial planner. For example, you plan to take a quick vacation at the end of the year or you intend to buy a bike for your daily commute. As you have to pay for the goal in near term, you should not be taking risk with the money. Opt for a bank fixed deposit or a liquid fund to keep the money. "You can also save regularly using recurring deposits," Sen adds.

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Income tax slab

Keep aside the super brains who are offered big packages, most millennials are in the early years of their careers and their income is taxed at the marginal rate of tax of 10 percent and 20 percent.

Most of the investment advice doled out takes into account the individuals who are in the 30 percent tax slab. For the high income individual the post-tax returns on the fixed deposits are low, given the tax impact. Let’s understand this with an example. A bank fixed deposit pays 7 percent for one year tenure. The post-tax returns for an investor in 30 percent tax bracket works out to 4.9 percent. However, if you are in 10 percent tax bracket, the post-tax return on fixed deposit is 6.3 percent.

“Bank fixed deposits offer competitive returns for individuals in nil and 10 percent income tax bracket,” says Joydeep Sen.

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Asset allocation and asset rebalancing

If you have been investing as per a stated asset allocation after taking into account your financial goals, there is a high chance that you will have some allocation to fixed income. At least when you are getting closer to your financial goals, you should be moving away from volatile stocks and equity mutual funds. In such circumstances, it makes sense to opt for bank fixed deposits if you are in the low income tax slabs.

Though you start with a particular asset allocation in mind, markets distort the allocation to stocks and fixed income. Especially when the stock markets are on a roll, one should rebalance his asset allocation at least once in a year. This may make you consider a shift from equity funds to fixed income. In such circumstances, you can still consider bank fixed deposits along with other options such as bond funds.

Manage the risks

Fixed income is seen as a risk-free space. However, it is not the case. Credit risk and interest rate risks are the prime risks that haunt the fixed income investors. If you have invested in bank fixed deposits of a nationalized bank then you are not taking any credit risk. The bank fixed deposits are not exposed to interest rate risk, however bond funds are. If the interest rates go up, then the bond funds see capital loss as the prices of the bonds in the portfolio fall. If you are not keen to take credit risk and interest rate risks, fixed deposits make a lot of sense.
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