The Government of India further reduced the rates on small savings instruments by 0.10% w.e.f. 1st July’2017. We have witnessed PPF interest lower than 8% for the first time. Term deposit rates are also around 7% for period up to 3 years. Bank fixed deposit rates have also fallen to 6.5/7% from peak of 10%. Traditional fixed return investors are in confused state of mind and are worried where to park the fund which can give them good returns.
Before that you need to understand where the core inflation is moving. The movement of inflation decides where the interest rate will move. CPI inflation has softened from the peak of 10% and at present it is around 2% only. Experts fear that CPI inflation for the month of June’2017 will be lower than 2% and hence it is very much possible that rates may fall further in coming months. Post demonetisation we have seen a lot of changes around us. The prices of food grains, pulses and vegetables have fallen sharply. Construction activity has been also affected. Crude oil is also trading at around $45 a barrel. Rupee has also appreciated against the dollar. All this has lead to sharp fall in inflation in recent past. We should also note that RBI’s current financial year’s inflation target is 4%. RBI’s stance for repo rate is at present neutral looking at international events and also possible jump in inflation post GST roll out but a rate cut is not ruled out in next review meeting.
Before starting any investment investor should finalise the goal for which they are investing. Goal based investment always help you in deciding the right avenue for your investment. The investor should stick to low risk investment avenues when the duration available is lower say less than 3 years. For a time horizon of 3 to 5 years they can take little risk and for the investment for 5 years plus investor can take higher risk products like balanced and equity funds of mutual fund. The second most important thing investor should look at is post tax return and not the gross income or interest rate attached to the instruments. Tax planning is one of the most important aspects of financial planning. Before making any investment decision you should know final outcome post tax. Investors in 20% and 30% tax slab should always stay away from taxable avenues like fixed deposits and postal schemes.
The following are the good options available in mutual fund which can not only give higher return compared to fixed deposits but are also tax efficient. The returns in the schemes are market linked and hence not guaranteed. This single point keeps lakhs of investors away from good investment options which I would like to highlight.
1) Arbitrage Funds:
The arbitrage means buying in cash market and selling the same quantity in future and option market. So if any fund or scheme does arbitrage means there is no equity risk as the equity position is hedged in f & o segment. This arbitrage fund can give you debt kind of return depending on the premium available on the stock. You can expect around 6% return from this option. The scheme is good option for higher tax slab investors because they are classified as the equity scheme for income tax purpose. So, the fund will be treated as long term after a period of one year and entire proceeds from arbitrage fund is considered as tax free after 1 year. In case invested for less than one year then investors will be liable to pay tax at 15% on gains which is lesser compare to 30% tax in fixed deposits.
2) Accrual Funds:
The funds mostly invest in corporate and government bonds with average maturity of around 3-4 years. The fund holds the paper till end so there is no major risk of interest rate movement. The fund can give 7-8% return at present which you can identify from the yield to maturity. You have to deduct fund management charges to arrive at final return. This is ideal if your investment horizon is 3 years plus so that investor also gets the indexation benefit. Indexation benefit will lower your net income tax liability and thus give you higher return compared to traditional platforms. Only thing to check is the quality of the papers hold by the scheme. Invest only in funds which hold AA+ and above papers so that risk is lower. In the recent past we have seen that to generate 1% extra fund managers have compromised on the quality of papers and invested in papers of AA- and also below that.
3) Fixed Maturity Plans:
This are debt oriented closed ended funds available for 3 years plus time horizon. In simple word you can say that these FMPs are like fixed deposits for fixed tenure offered by mutual fund houses and automatically mature after the period is over. These also work similar to accrual funds and invest in corporate bonds and commercial papers. The yield is also same which largely depend on quality of papers selected for investment. The only difference is accrual funds are open ended funds in which you can increase the investment in between and also redeem but this facility is not available in FMPs.
4) MIP funds:
These monthly income plans are riskier than above three categories as these funds invests 15-20% in equity and balance 80-85% in corporate and government bonds. This fund is suitable for time horizon of 3 years plus and those who understands the risk of equity. Again indexation benefit is available after holding the fund for 3 years as these funds come under debt category. I always advise my clients to go for MIP funds when time horizon is 3 years plus. At present 3 year return on these funds is in double digit but surely with some extra risk.