Fixed income: Opt for longer tenure to earn higher interest rates

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Published: June 3, 2020 12:50 AM

With banks slashing FD rates, investors have to look for alternative debt products like post office FDs, PPF, EPF/ VPF and Bharat Bond ETFs for higher post-tax returns

Even after the interest rate cut in small savings, the schemes still offer higher rates than bank deposits. Even after the interest rate cut in small savings, the schemes still offer higher rates than bank deposits.

At a time when Reserve Bank of India has stopped the government of India 7.75% (taxable) bonds and the country’s largest lender, State Bank of India, has reduced interest rates on fixed deposits (FD) of one to less than two-year tenure to 5.1%—a 17-year low—risk-averse debt-oriented investors will have to look at longer tenure to earn higher returns. Investors will now have to look at various ways to reduce the reinvestment risk and calculate the post-tax returns before investing. Here are some fixed income investment options to earn higher interest rates.

Fixed deposits
While banks have been slashing FD rates, the government in April too had slashed small savings rates by up to 140 basis points with effect from the first quarter of 2020-21. Even after the interest rate cut in small savings, the schemes still offer higher rates than bank deposits. While the interest rate for five years and up to 10 years term deposits of SBI is 5.4%, the rate of 5-year post office time deposit is 6.7%. As returns are taxed, post-tax the returns (at 31.2% tax rate) of SBI deposit will be 3.72% and that of post-office deposit will be 4.61%. So, one can lock in investment in small savings at a higher rate now before rates fall further.

Public Provident Fund
Public Provident Fund (PPF) is one of the most popular investment options for individuals because of high tax-free rates —it has exempt, exempt, exempt tax structure—and carries no risk. At 7.1% current interest rate, it gives an effective yield of 10.32% if Section 80C tax exemption is availed at 31.2% tax rate. At 20.8% tax rate, the effective yield will be 8.96%. So, those in the high tax bracket can use PPF for accumulating long-term corpus. However, rates of PPF, like all other small savings schemes, are revised every quarter. The maturity period is 15 years and the account can be extended within one year of maturity for block of five years. Even the maturity value can be retained without extension and without any further deposits.

For salaried employees, Employees’ Provident Fund (EPF) is an ideal way to save for long-term goals provided the subscriber doesn’t withdraw the corpus at every job change. Investment in EPF gets a tax break of Rs 1.5 lakh under Section 80C, the interest earned is tax free and the final withdrawal after retirement is also tax free. The retirement body has decided to provide 8.5% interest rate on EPF deposits for 2019-20, which is one of the highest among all fixed income instruments. However, the rate has to be ratified by the finance ministry.

Employees have the option to increase allocation through Voluntary Provident Fund (VPF) and earn the same interest rate offered on EPF. The voluntary contribution can be up to the full basic salary and dearness allowance. So, at 8.5% interest rate for EPF/VPF, the effective yield if Section 80C benefit is also availed will be 12.35% for those at 31.2% tax bracket. At 20.8% tax bracket, the effective yield will be 10.73%.

Bharat Bond ETF
The second tranche of Bharat Bond ETF maturing in April 2025 and April 2031 will be rolled out in July by Edelweiss Asset Management Company. It will invest in AAA rated paper of state-owned companies and the ETF will hold the bonds till maturity. The credit risk in Bharat Bond ETFs is next to nil. As on June 1, 2020, the yield to maturity for the bonds issued in the first tranche for April 2023 and April 2030 is 5.76% and 6.84%, respectively.

Joydeep Sen, founder,, says Bharat Bond ETF combines good portfolio credit quality, portfolio maturity run-down thereby reducing volatility risk and secondary market liquidity. “To be noted, at the date of investment, the remaining maturity of the product should be more than three years, to avail of long term capital gains/ indexation benefits,” he says.

Tax-free bonds
Tax-free bonds listed in the stock market makes wise investment as investors can lock-in their capital for a longer tenure and earn tax-efficient returns. While there is no tax exemption under Section 80C, the interest accrued is completely tax-free under Section 10(15)(iv)(h). These bonds are from public sector companies such as IRFC, PFC, NHAI, HUDCO, REC, NTPC and NHPC. 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.

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