The lowering of interest rates of fixed-income products such as bank deposits and small savings schemes will impact risk-averse investors. As falling interests will reduce the returns, individual investors will now have to look at various ways to reduce the reinvestment risk and diversify their asset portfolio. As most fixed-income products come with lock-in period, investors must look at their near, medium and long-term liquidity needs and financial goals and even post-tax returns before investing.

Small savings: Still better than bank deposits

After Reserve Bank of India cut the repo rate by 75 basis points (bps) to 4.4% on March 27, banks have reduced their deposit rates, too. In fact, FD rates have been coming down for the past six months. State Bank of India has cut interest rates on FDs, twice in March.

Similarly, in one of the steepest-ever cuts, the government slashed small savings rates by up to 140 basis points with effect from the first quarter of 2020-21. While the cuts will reduce the earnings of depositors, it will help banks to reduce their lending rates as they have always cited that the high small savings rates as an impediment to effective rate cut transmission.

Even after the rate cut, the rates of small savings are still higher than bank deposits. While the interest rate for 5-year term deposits of SBI is 5.7%, the rate of 5-year post office time deposit is 6.7%, a difference of 100 bps. One bps is one-hundredth of a percentage point. Popular schemes such as Public Provident Fund (7.1%) Sukanya Samriddhi Yojana (7.6%) have the added tax benefit which results in higher returns. So, investors should invest up to `1.5 lakh in a financial year in these schemes and get higher tax-free returns in the long-run. The interest rates of other small savings schemes such as 5-year National Savings Certificates will be 6.8%, 5-year Monthly Income Scheme is (6.6%); 124-month Kisan Vikas Patra (6.9%) and Senior Citizen Savings Scheme at 7.4%.

Company deposits: Tread with caution

It will be tempting for investors for go for company deposits as they pay higher interest, but they can be risky and may default on payment of interest and even the principal amount. A host of real estate companies have defaulted on repayments in the past, and more recently non-banking financial companies such as Dewan Housing Finance Ltd have defaulted on repayments and stopped all premature withdrawals of its deposits.

Company fixed deposits are unsecured loans, where repayment of principal and interest are not guaranteed. In case of any default or delay, investors have little recourse. An investor must analyse the financial statements, performance of the company and its management to take an informed decision before investing in company deposits.

Long-term needs: Go for tax-free bonds

Long-term investors should look at tax-free bonds of public sector companies like IRFC, PFC, NHAI, HUDCO, REC, NTPC and NHPC. As there have not been any fresh issues of such bonds since 2016, investors can buy these bonds from the secondary market. Not having to pay tax on the interest earned on such bonds makes them more attractive than other taxable debt instruments. While the interest payments on these bonds are tax free, there would be capital gains tax if an investor sells before maturity at a profit.

Tax-free bonds makes wise investment for those in the higher tax bracket (30%) as dividends will be taxed in the hands of the investor at his marginal rate from this financial year. Investors can lock-in their capital for a longer tenure and earn tax-efficient returns. They are an ideal investment option to build a retirement portfolio. Under tax-free bonds, while the investor does not get any tax exemption under Section 80C, the interest accrued is completely tax-free under Section 10(15)(iv)(h). Even the returns are higher in tax-free bonds as compared with bank term deposit rates.