Fixed Deposit are back with a bang...

A brief on Fixed deposits and other Fixed tenure plans

Rising interest rates are always associated with expensive loans and an overburdened borrower. But this is just one side of the coin. The other side of the coin reflects the rising deposit rates, which have added some zing to this safe investment product of the common man.

 
The bank fixed deposit rates (FDs) have increased from the lowly 6.75% to the current 8.50%. So the fact is rates are up inflation is up there in double digits as an investor of FD’s what you should be doing.

There is no single answer to this question. Investors should consider the time left before the date of maturity of their FDs before breaking the FD. For instance, if the FD is nearing maturity, it may not be a prudent decision to opt for a premature withdrawal. You will lose some interest income on that deposit, since the interest rate is calculated on an annualised basis.

Again as an inquisitive investor my suggestion would be to start evaluating between the loos on closing the FD and the extra gains on the New FD. Sometimes the loss in the interest income may offset the gain you earn from higher deposit rates. 

If you had invested Rs 100,000 around four months back for one year FD at 7.00% and the rate for one-year deposits has gone up to 8.25%, then on breaking the previous one, the rate applicable for four months technically should be [ 100,000 * 7/100*4/12] Rs.2333. which you can again reinvest at 8.25%. Not that simple you underestimate one of the biggest cons in the money market the BANKS.

A bank can charge you a pre closure charge and not allow you the entire interest accrued on your FD. A bank could technically charge anywhere between 1-2% on you FD as pre-closure charge. So instead of allowing you to calculate 7% he could take away about 2% from your agreed interest and make you a payment of only [ 100,000 * 5/100*4/12] Rs.1666.

   
But certain banks have a defined list of emergencies under which a customer can be spared from the premature withdrawal penalty. Like unexpected financial emergencies such as illness, death of a family member etc. But this waiver happens on a case-to-case basis and the customer has to convince the bank about the nature of his emergency.

All is not lost rates are at a favorable peak my suggestion would be to talk to your banker discuss how he could renew the rate for you. Some banks offer renewal of FD’s without charging a high pre closure charge. Though the rates received in this case would not be the highest offered by the bank but still it could be better by about a percent or two.

Most of the company FDs still offers a higher interest rate compared to that of bank FDs but one should also consider the financial soundness of the company. The safety and return on company deposits depend on the rating. Usually higher the rating, lower is the return Rs "Typically the return on an AAA-rated company comes very close to that of a bank deposit as the investor is assured of the company's financial soundness.

For example, the rate offered by LIC Housing Finance on a one-year deposit is 7.6%. It is rated FAAA by Crisil, which indicates the highest degree of safety regarding payment of interest and principal. For the same period, SBI is offering 7.75%. Now this rate is comparable because the company has been given a safe rating. Also, in most of the cases, it takes a longer time to get the credit in case you want to break your company FD before its due maturity.

Another sound fixed tenure interest generating scheme is an FMP also known as FTP. Fixed maturity plans and fixed tenure plans are schemes launched by mutual funds. They more or less offer the same tenure as a bank FD. Varying terms commonly offered are 91 days, 180 Days, 370Days and 520 days.

Given that the interest income on bank deposits is fully taxable, the net yield is much lower. If a person is in the highest tax bracket, then the actual return after tax of 30.9% is just 6.3% on a 9% FD. An FMP here is a better tax efficient product as Mutual funds offer dividends instead of interest payouts and dividends are charged only a 14%. If the FMP has a tenure of more than 1 year then the taxation becomes even more attractive as income can be categorized as capital gain and we need to pay only10% without or 20% with indexation which in most cases due to our high inflation is always at a loss.

Before investing in FMP’s my suggestion would be to speak to a certified investment advisor as he will explain to you how exactly the product works and why it gives a higher return when compared to a bank FD. In buying FMP my suggestion is to always understand what will be the portfolio of the FMP as an FMP will technically hold a combination of CD’s and CP’s.  CD are usually offered by banks and CP’s are offered by rated companies.

My suggestion would be to start picking your favorite fixed income product as the rates are at all time high and I urge investors to not miss this opportunity to book into some long term Fixed deposit plans.