Bet On Debt!

Debt instruments protect your capital. This becomes all the more significant in times of a downturn - after all 8 per cent guaranteed returns are a God send when you consider the fact that markets are down 50 per cent over the past one year and a few stocks are down by as much as 90 per cent from their peaks. If you have a house to run, it’s but natural that you require the safety of principal amount with a steady predictable income. Some of the instruments that you can consider to safeguard your interests are:

Bank Fixed Deposits (FDs)
Bank fixed deposits (FDs) offer a safe haven to park funds in distressed times. While the nature of this instrument is very simple because there is a fixed rate of interest offered for a specific period of time, there are various other factors which need to be kept in mind before investing in FDs. While most investors just look at the interest rate being offered, it is important to gauge the financial strength of the bank. This is more so if you are investing more than Rs 100,000 because deposits are insured only till this sum. On the whole, however, selecting from among the public and private sector scheduled banks should not pose a problem as they are extremely safe. “Bank fixed deposits provide a conservative bias to the portfolio and are suitable for those who are risk-averse,” says J. Khanzada, ex-banker and product specialist. “A retired person would like to invest in risk-free instruments and get back the principal after a certain period and may, therefore, opt for a shorter time-frame. However, a young person may opt for a longer time-frame as he is earning and may not need the money in the near future,” explains Khanzada. P J Patil, who retired after 34 years of service with Reliance Energy, endorses this view, saying “I decided to put my retirement money in safe and secure investment avenues which will give me steady returns after I retired from Reliance Energy in August 2008. Hence, I invested most of my savings in nationalized and large private sector bank FDs (State Bank, Bank of Maharashtra, HDFC Bank and ICICI Bank) and National Savings Certificates. All these investments fetch a rate of interest of 10.5 to 11 per cent, including additional interest of 0.5 per cent for senior citizens.” R S Seths, another investor, says “I liquidated most of my equity portfolio over the last couple of years. Now, most of my investments are in bank fixed deposits and National Savings Certificates. My investments in debt instruments are safe and fetch good returns.”

Period of deposits is another point to consider. Often, a higher rate of return is available for specific time maturities like 10 per cent for 360 days or 9.5 per cent for 400 days and so on. In such a situation, selecting the right period for the deposit will be crucial. If there is an expectation that the rates will fall in the near future, investors will be better off by locking themselves in a long-term deposit. Amount per deposit is also an important criteria. For instance, if the deposit is above Rs 15,00,000, the bank offers a special rate, which is higher than the normal rate. In such[PAGE BREAK]

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circumstances, sometimes it makes sense to consolidate the investments and earn a higher rate of return. However, in some other cases, it might make greater sense to break up the total amount into smaller deposits and spread it across various periods. For instance, if an investor has Rs 100,000, he could divide it into Rs 50,000 for three years, Rs 35,000 for 500 days and the remaining Rs 15,000 for a one year deposit to garner the maximum returns, along with reduced tax liability and meeting liquidity needs. One should always make it a point to read the fine print since there can be quite a bit of difference in various rates of interest being offered. For instance, it’s important to consider the rate of return per annum instead of a flat figure. That is, if there is a deposit for 270 days, where the rate is 10 per cent per annum, the actual amount earned in absolute terms is 7.5 per cent. Similarly, if there is a deposit for 300 days, where the return is 8 per cent, then the per annum return is 9.6 per cent. Such details are very important and the investor will do well to consider these figures rather than just rush towards the highest figure.

There are other additional factors that are involved with a deposit that also need to be considered. In some cases, there is a higher rate for senior citizens as well as employees and channelling the deposit through this route will be beneficial for the investor. Also, sometimes there might be an insurance cover available along with the FD and several other banking facilities like opening a bank account. Take advantage of all these factors when investing in the FD.

Public Provident Fund (PPF)
PPF investments are recurring in nature and run over a 15-year period. Annual contributions are mandatory to keep the PPF account active, the minimum and maximum investment amounts being pegged at Rs 500 p.a and Rs 70,000 p.a., respectively. Only contributions of upto Rs 70,000 p.a. are eligible for tax benefits under Section 80C. At present, PPF investments yield a return of 8 per cent p.a. Returns are assured but not fixed i.e. the rate of return is subject to upward or downward revisions without impacting returns. With no provision for a regular interest payout, PPF fares rather poorly on the liquidity front. Withdrawals can be made only from the seventh financial year. Furthermore, the amount that can be withdrawn depends on the balance in the PPF account in the earlier years. PPF investments are exempt from tax under Section 10 (11) of the Income Tax Act, apart from being eligible for Section 80C tax benefits. The two biggest advantages of PPF is that the returns are tax-free and on maturity the investment attracts no tax liabilities.

Given that investments in PPF run over a 15-year period and that annual contributions are mandatory, it is an ideal avenue to build a corpus for long-term needs like retirement and children’s education. It will appeal to investors who accord higher priority to returns over liquidity.[PAGE BREAK]

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National Savings Certificate (NSC)
Investing in National Savings Certificate (NSC) entails making a lump sum investment for a 6-year period. While the minimum investment amount is Rs 100, there is no upper limit. Presently, investments in NSC earn a return of 8 per cent pa, compounded on a half-yearly basis. In other words, Rs 100 invested will grow to approximately Rs 160 on maturity. Unlike PPF, the rate of return in NSC is locked in while investing. Investments of upto Rs 100,000 p.a. are eligible for tax benefits under Section 80C. Furthermore, the interest accruing annually is deemed to be reinvested, hence it qualifies for deduction under Section 80C. But interest income would be added while computing of total income while computing total income. This may attract tax liability, depending on total income.

Given its nature (lump sum investments), NSC is best suited for gainfully investing one-time surpluses and to provide for needs that will arise over a corresponding (6-yr) timeframe. Hence, NSCs are apt for investors seeking returns over liquidity.

Post Office Time Deposits (POTD)
POTDs are fixed deposits from the small savings segment. While investors can opt for 1-year, 2-year, 3-year and 5-yr POTDs, only the 5-yr ones are eligible for tax benefits under Section 80C. A 5-year POTD earns a return of 7.5 per cent p.a., the interest is calculated quarterly and paid annually. In other words, Rs 10,000 invested in a 5-year POTD will deliver an interest income of about Rs 771 p.a. The minimum investment amount is Rs 200, while there is no upper limit. POTDs fare favourably on the liquidity front, thanks to the annual interest payouts. Premature withdrawals are permitted after 6 months from the date of deposit, the same entailing a penalty in the form of loss of interest. Investments of upto Rs 100,000 pa are eligible for tax benefits under Section 80C with the interest income being chargeable to tax.

Post Office Monthly Income Scheme (POMIS)
POMIS generates a monthly income for investors. The minimum investment amount is Rs 1,500, conversely, the maximum amounts have been pegged at Rs 450,000 and Rs 900,000 in case of single and joint accounts, respectively. Investments in POMIS earn a return of 8 per cent p.a. and the investment timeframe is 6 years. On maturity, investors are eligible to receive a 5 per cent bonus on the original sum invested.[PAGE BREAK]

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With a monthly interest payout, POMIS fares better than all its peers on the liquidity front. Premature withdrawals are permitted after completion of one year from the date of making the investment. Investments in POMIS are not eligible for any tax benefits. Also, the interest income is chargeable to tax.  POMIS is suited for investors like retirees and senior citizens who seek assured and regular income.

Senior Citizens Savings Scheme (SCSS)
Unlike the other avenues discussed so far, SCSS is open only for senior citizens. Individuals who are 60 years of age and above can invest in the scheme, those who have attained 55 years of age and have retired under a voluntary retirement scheme can also participate in the scheme, subject to certain conditions being fulfilled. The minimum and maximum investment amounts are Rs 1,000 and Rs 15,00,000 respectively. Investments in SCSS run over a 5-year period and earn a return of 9.0 per cent p.a.

Given that SCSS is targeted at senior citizens, the liquidity aspect has been adequately addressed, with interest payouts made on a quarterly basis i.e. on March 31, June 30, September 30 and December 31, every year. Premature withdrawals are permitted after the expiry of one year from the date of opening of the account. Investments in SCSS are eligible for tax benefits under Section 80C.

Company FDs (CFDs)
Apart from banks, even companies offer fixed deposits. However, it is not be as safe as a bank deposit because banks in India have the backing of the central government, whereas company deposits are ‘unsecured’. This means, you have no lien on any asset of the company, in case it goes into financial difficulties and is wound up. Tata Motors’ recent fixed deposit scheme which offers an interest rate of 11% for three-year deposits (0.5% additional interest for senior citizens, employees and shareholders in Tata Motors) has put CFDs back into the limelight and many of the top companies are lining up to raise funds through FDs. Most experts advise sticking to fixed deposits with nationalised banks as a reputed AAA-rated company would offer anything between 7 per cent to 9 per cent which reduces to less than 6 per cent if you are in the higher tax bracket. Moreover, it is more riskier than bank FDs.

Debt mutual funds
A debt fund is a diversified portfolio of assorted debt and money market instruments managed by professional managers of a mutual fund.[PAGE BREAK]

Debt funds can be categorized into various sections based on the specificity of securities they invest in, time-horizon and the objective. These would be namely: income/ bonds funds, liquid/ money market funds and gilt funds. The maturity of securities, which these debt schemes invest in, may vary according to the scheme’s objective and investment strategy. Debt mutual funds also gain significant tax arbitrage advantage against fixed deposits. However, although the number of debt funds are rising, the returns may not necessarily rise when the interest rates are rising.

Always allocate partially to debt
What had began as a global liquidity glut four years ago has eventually ended as a liquidity crisis in 2008! This has resulted in a complete turnaround for risk-averse investors. Stock markets have plummeted and interest rates have remained stable during this period. This reinforces the fact that irrespective of external factors one should always stand by their risk profile and park their funds in debt instruments in these uncertain times. As a standard rule, always have some portion of assets in debt instruments, irrespective of bull or bear run in stock market.