Fixed deposit rates have fallen. What should investors do?

Adhil Shetty

Interest rates have been trending downwards over the last two years or so. For consumers, this meant cheaper loans, but yields on bank deposits have also fallen.

The interest rates offered by State Bank of India were trending in the 8+ percent range around 2015. They now been slashed to 6.25 percent for the two to three year deposit. The fall in returns needs to be viewed along with the taming of cost inflation, which suggests that low interest returns are not necessarily a bad deal investors.

Impact of rate cut

However, investors must consider their post-tax returns from bank deposits. Let’s say you invest Rs 100,000 in a deposit today for 6.25 percent. This would generate pre-tax returns of Rs. 6250 for the first year.

Assuming you’re already earning more than Rs. 10,000 in interest from various savings and deposit accounts, here’s how you will be taxed: Rs. 1250 in the 20 percent bracket, or Rs. 1875 in the 30 percent bracket.

This reduces your post-tax returns to 5 percent in the 20 percent bracket, or 4.3 percent in the 30 percent bracket. This may seem terribly unappetising to most investors.

So, what should investors do?

Fixed deposits are important from the perspectives of maintaining liquidity, generating conservative returns, and safety of money. However, bank deposits can also be high tax-inefficient, and reduce your ability to create wealth efficiently.

So here are four ideas for investors to consider if they want to optimise returns with capital safety.

> Invest in deposits, but within limits. For example, you can set this limit to six to twelve times your current monthly income. This sum should be enough to cover you through most short-term situations, including emergencies. This also helps you maintain liquidity with lower tax incidence.

> Pick some liquid mutual funds. Beyond the above-mentioned limit for fixed deposits, you can maintain further liquidity by investing in some liquid mutual funds. These are risk-free instruments with returns comparable to bank deposits and typically have no exit loads. Also, you are taxed on your returns only when you redeem the investment unlike a bank deposit, where you may be paying TDS annually.

> Liquidity should not equal insurance. If you’re parking money in deposits for situations such as health emergencies, don’t. Instead, buy insurance. Health insurance for every member of your family would be a cheaper alternative than having to expend your savings and liquidity on a hospitalisation.

Similarly, make sure your properties and vehicles are adequately insured, so that you don’t lose liquidity during accidents and repairs.

> Have long-term plans. If you’re still left with surplus cash after following the ideas above, it’s a good problem to have. You can allocate this cash towards medium and long-term investment goals. This could be done by picking the appropriate instrument such as equity mutual funds or Public Provident Fund.

Fixed deposits help you maintain liquidity and keep your money safe. However, in a falling interest rate scenario, you must combine the use of deposits with other investment instruments to get better returns and tax efficiency.

Author is CEO & Co-founder of Bankbazaar.com