Even after many years of financial sector reforms and tax benefits, investments in traditional savings instruments like bank fixed deposits, company fixed deposits, life insurance, small savings, etc., still form a large portion of overall savings of Indian investors. In 2015-16, as per RBI data, out of the incremental savings of Rs 14,899 billion, 80% went into these instruments. As per a 2015 survey of investors by SEBI, 95% of rural households have bank savings while 47% and 29% of respondents use savings instruments from life insurance companies and post offices, respectively. Majority of people are losing out on opportunities to earn better returns at reasonable risk levels due to lack of awareness.
Debt mutual funds
Debt mutual fund schemes provide decent returns comparable or higher than that of other fixed income securities. Investments are made in various types of debt instruments which differ in credit quality, maturity and rate of interest. Credit quality is defined by the rating allotted to the instrument by independent rating agencies. Higher the rating, safer is the instrument and consequently lower is the interest rate. Investors will do well to track the rating profile of instruments in which the debt scheme has invested monies to ensure that the rating profile is in tune with their own risk profile.
Debt funds are highly liquid as entry and exit is available at any time (subject to exit loads). Debt funds are tax efficient since while calculating capital gains on sale of units (after three years), the cost of purchasing the units shall be increased by the inflation index during the period of holding.
In non-convertible debentures (NCDs) and corporate fixed deposits, the investor has to take a call about the risk involved in investing in a particular fixed deposits or NCD. In the case of a mutual fund, the fund manager has the expertise to evaluate the risk and take appropriate calls of entry / exit based on the interest rate cycle prevailing.
If we go the next step and compare the post-tax returns, on an investment of more than three years, debt funds will yield a higher net return compared to fixed deposits or NCD.
The longer the duration of the debt funds the higher is the outperformance over traditional savings instruments. For example, while Liquid Funds and Ultra Short Term Funds, which are utilised for investments up to one year, provide returns of 7- 8.5%, certain Income Funds or Long Term Gilt Funds have returned 10–13%. On the other hand, five years maturity fixed deposits or 15 years maturity Public Provident Fund currently provide only 7.9% return.
Bank fixed deposits or post office savings schemes offer safety of investment. Since post offices are backed by the government and fixed deposits are backed by large banks, some of which are PSUs, the risk of default or credit risk is very limited. Investors are hesitant to invest in debt mutual funds as they are worried about the safety of principal.
If the investor wants absolute safety of investment and low or no taxation benefit, then he can consider traditional investment options. However, by taking a calculated risk, marginally higher than the traditional savings instruments, an investor can earn superior returns which can be beneficial in wealth creation over a long period of time.
The writer, Deepak Jasani is head, Retail Research, HDFC Securities