Transfer the idle cash in your savings account to short-term debt funds to earn slightly higher post-tax returns
THE government has demonetised R500 and R1,000 currency notes and has restricted ATM withdrawals to R2,000 per day until November 18 and withdrawals from bank accounts to R10,000 a day and R 20,000 a week till November 24. This move will reduce households’ allocation towards physical assets like gold and property and give a push to financial savings, which is around 7.7% of GDP as compared with 13% for physical savings.
Analysts expect higher current account savings account (CASA) of banks as more money flows through the banking channel. Improved liquidity will drive up demand for bonds and put downward pressure on yields.
Beyond savings account
So, instead of parking money in your savings bank account that would earn 4% (though a few private sector banks offer 6%), individuals can look at various options in mutual funds to invest money for the short term and gain slightly higher returns. Asset management companies have various types of debt funds that invest in fixed income securities of different time horizons.
Liquid and ultra short-term debt funds do not invest in equity. These funds are invested in the debt market such as government papers, commercial papers, treasury bills, etc. Investment in debt funds of short tenures can be made through the websites of the fund houses by paying online or by submitting a physical application and cheque or draft.
Post-tax debt funds of mutual funds give better returns than bank deposits, especially for those in the highest tax bracket. Moreover, these funds are very liquid. Once a redemption request is placed, money is credited into the bank account the next day.
It is ideal to park surplus cash for short periods as the assets invested are not tied up for a long time. The period of investment of liquid funds could be as short as a day to 91 days and these give money market rates. However, returns are not guaranteed as it depends on how the debt market performs.
Ultra short-term funds
These funds invest in very short-term debt securities with residual maturity of more than one year. Those who have surplus funds for six to nine months and are willing to take marginal risk to earn higher returns can park their money here. In the past one year, ultra short-term funds gave 8.7% returns and liquid funds gave 7.7% returns.
Tax-wise, all debt based mutual funds are considered long-term when held for more than three years and short-term when held for three years or less. Short-term gains are taxed at the slab rates of the individual and long-term gains are taxed at 20% with indexation.
However, both liquid and ultra short-term funds face interest rate risk and credit risk. Interest rate risk would be due to a change in the price of a bond because of change in the prevailing interest rate. Since underlying investment in liquid funds have a maturity period of less than 91 days, interest rate risk is less as compared to higher maturity funds.