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Wednesday, August 17, 2022
FIXED RETURN PRODUCTS ON YOUR MIND?

HERE’S A DECISION-MAKING FRAMEWORK!

In this article, I try to put in place, a decision making framework to help individuals make sound and informed investment decisions w.r.t Fixed Return Products. Since Bank FDs and Debt Funds are two of the most popular fixed return instruments often talked about in the same breath, it makes perfect sense for me to use these two products as examples to illustrate a decision making framework.

Here’s a Step by Step Consideration of the key factors involved:

Begin with gaining clarity on the Purpose of Investing:

Fixed income products are best suited for short term goals with a time horizon of less than 5 years. For longer time horizons, one must consider looking at equity. Hence at the initial stage, one must be clear about the goal and the time in hand to achieve that goal.

Once the purpose of investing is clear, one would look at evaluating the popular options on the following parameters:

1. Returns (without accounting for the impact of taxation) – In terms of Returns before taxes, there may not be much to choose between a Debt MF and a Bank FD of comparable duration. At times there could be a difference in favour of Debt MFs but that too is very nominal.

2. Tax Efficiency:

a. Returns of Bank FDs are taxed at one’s applicable income tax slab rate. In the case of Debt MFs, for a period less than 36 months, the gains will be subject to STCG Tax and computed at the applicable Income Tax Slab Rate (similar to Bank FDs). However, Debt MFs, if held for a longer time period of 36 months or more, the gains will be subject to LTCG Tax and will be levied at 20% after indexation. Indexation helps bring down the tax liability drastically.

b. In the case of Bank FDs, TDS becomes applicable if the returns for the year exceed Rs.40,000/- annually. Debt MFs, on the other hand enjoy the benefit of deferred taxation; No TDS deduction is applicable on Debt MFs.

3. Risk (Credit Risk, Interest Rate Risk, Liquidity Risk):

a. Credit Risk:

Bank FDs are insured to the extent of Rs.5,00,000/-. Any amount over and above this is exposed to the risk of default. Debt MFs do not enjoy this benefit of insurance. However, MFs are tightly regulated entities. Diversified Debt Funds with highly rated underlying holdings, help counter the risk of default by spreading the risk across holdings.

b. Interest Rate Risk:

Bank FDs aren’t exposed to Interest rate risks. Open ended Debt Funds, especially the ones with longer duration papers, are exposed to Interest Rate Risk and hence can be highly volatile. Closed-ended funds such as FMPs do not suffer from interest rate risk and hence their returns are more or less predictable. Liquid and overnight Funds which carry very short term maturity papers are also not exposed to Interest Rate Risk.

To effectively navigate through interest rate risks, one must choose instruments with average maturity of underlying papers coinciding with one’s intended holding period.

c. Liquidity Risk:

Bank FDs are liquid but liquidity here comes at a cost in terms of penalty levied on the returns. On the other hand, Good Quality Debt MFs of reasonable size offer very highly liquidity and redemptions do not attract any penalty.

Although I may have quoted only two popular fixed return instruments here in my illustration, this framework can be extended to a wider range of fixed return products ranging from Post Office Deposits, Small Savings Schemes, Bonds, Debentures, etc. Evaluation of these products against each of the above parameters and aligning them with the expected time horizon will give investors clarity on picking the best available alternative.

About the author
Deepak Rameshan,
CERTIFIED FINANCIAL PLANNERCM, Dip TD, MMS
Deepak Rameshan is a CFPCM professional, and has been working in the financial services domain for close to 13 years. He holds a Master’s Degree in Management Studies and a Diploma in Training & Development and has been actively engaged in Training & Content Development during this period. As a Personal Finance Enthusiast and an avid researcher of the subject, Deepak has delivered several Investor Awareness Workshops over the years covering areas such as Risk Planning & Insurance, Retirement & Goal planning, Tax Planning and a few other specialized areas. He takes keen interest in writing and has penned numerous articles for this blog, addressing some of the most relevant concerns that individuals face with respect to their finances. “Financial Planning Standards Board Ltd. (FPSB Ltd.) is the proprietor of the CFPCM, CERTIFIED FINANCIAL PLANNERCM and marks outside the United States, including in India, and permits qualified individuals to use these marks to indicate that they have met FPSB Ltd.’s initial and ongoing certification requirements.” Watch this space for more insights on Personal Finance…
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