Sunday, January 29, 2012

Why This Might be the Right Time to Invest in FDs and Debt Instruments

The Reserve Bank of India has been in the news for continuously raising interest rates - as much as 13 times in 19 months, trying hard to control inflation which seemed to be unaffected by  these interest hikes! People who had taken loans had to face a hike in their EMIs almost every 2 months & groaned at every instance of rate hike. High interest rates coupled with global uncertainties, put brakes on the high growth rates that India was exhibiting and all industries were up in arms against the rate hikes that RBI was bringing about. However last week RBI announced a cut in the CRR  which is a signal that RBI has now decided to soften its stand. Though it has left interest rates unchanged, the CRR cut would infuse more liquidity in to the economy which came as a welcome relief to the industries & the stock market.

But what does this mean for a retail investor?

This could mean that there is a high chance that interest rates have almost peaked out and that we are not far from seeing interest rates moving downwards. There is a high possibility that we are again at that stage of the debt market cycle – like the one we saw in 2008 after which the interest rates moved downwards. If you have surplus cash which you want to invest safely with an assured fixed rate of return, this maybe the best time to do that. Banks are currently offering attractive interest rates on their Fixed Deposit products and this maybe a good time to consider investing in them. If you want an investment with the highest degree of safety, look at opening an FD.

While there is no doubt that Bank Fixed Deposits come with the highest safety, the biggest disadvantage about them is that, you pay up to 30.6% tax (if you happen to be in the highest tax bracket) on the interest income. However, if for over 1 year, you were to invest in debt instruments (like debt mutual funds), then your tax pay out would be only 10.3%.This strategy gives you better post tax returns (more than Fixed Deposits) and without being subject to higher risk such as the one in equities or stocks. Debt mutual funds help you get access to a diversified portfolio of debt instruments which you may not be able to do as an individual, unless you are investing a over 10 million rupees. Hence Debt Mutual funds offer an easy way of benefiting most from high interest rates.

To conclude, seeing the stance that RBI has taken, it is reasonable to speculate that RBI would stop hiking interest rates further (and hence stop hurting growth) and therefore interest rates would soften in the coming months. If you would like to benefit from these high interest rates & have a low risk appetite, you could consider a debt instrument like a Bank FD or a Debt Mutual Fund to lock in to the high interest rates.

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