Should risk-averse investors look beyond investing in Fixed Deposits?

October 01, 2020 7:36 PM

In our view, a better way to handle the liquidity requirements without having to incur costs is to look at other short-term and other long-term fixed income investment options available in the market.

household income, economic recovery, employment, unemployment, rise in incomeIndia is nearly eight months into the lockdown, but the recovery in household incomes is very slow.

As grim as this may sound, Warren Buffet hit the nail on the head when he quoted this to emphasise the importance of savings. This is exactly what our parents and grandparents have been advocating all along. And rightly so, because there is a continuous struggle between instant gratification on one hand, vis-à-vis long-term happiness. Unfortunately, our brain is programmed to respond favourably to short term happiness over long term goals and therefore it calls for a lot of discipline to save a portion of the money earned and invest the same money to make it grow.

While the investment plan is designed basis one’s return expectations, investment time horizon, risk appetite, short-term and long-term goals, certain financial instruments are essential for every portfolio and one of such instruments is Fixed Deposit (FD).

FD is one of the most popular and traditional investment options available out there. And rightly so, because FD is one of the safest options, especially when you compare them with stocks or any other market-linked instruments. With low volatility, the corpus that you set aside in FDs serves as a great way to ensure that your capital is safe.

FDs are ideal for investors who are averse to taking risks. When you put your money in FDs, you basically lock the amount for a fixed period. Interest gets accumulated on the deposited amount and gets added to the principal amount after every specific interval. It also depends on the type of financial institution offering the FD and its credit rating – public sector, private sector, small finance banks, NBFCs or corporates.

The tenure of the FD can range from 7 days to 10 years. Some of the key benefits FDs offer are:

1. Risk Management instrument – Safe investment option with guaranteed returns
2. Backed with deposit insurance of Rs. 5 lakhs
3. Can help with tax-saving u/s 80C of the Income Tax Act, 1961
4. Can be used as collateral to avail loan against it
5. Simple to understand even for the common man.

But FDs are not the only option available in the market, there are other debt investment options as well, which compare well and may be outperform the traditional FDs. Let us have a look at some of the other Debt investment options available:

One of the things you will notice from the table above is that FDs are not the best options when it comes to the cost of liquidation. Since one needs to predefine the tenure of the FD at the time of investing, in the event of any unforeseen requirement of the funds, one needs to go for premature withdrawal of the FD which not only attracts a penalty but also the promised return on the FD comes down, which is a double whammy. This penalty in some instances can be up to 0.5 per cent of the invested funds and therefore could lead to significant financial loss.

Now, this is one problem that a lot of investors face now and then, which gives way to a thought of investing in multiple FDs of smaller denominations so that in the event of a need for premature withdrawal, only FDs amounting to the requirement can be taken out and not the entire investment value. Though one could save some cost with this strategy, there is a flaw in this thought process.

As, investing in multiple FDs of smaller denominations is not only inconvenient, the overall returns to come down since the institutions offer a higher rate of interest on FDs of higher denominations and hence one looses out on availing higher rates as well.

In our view, a better way to handle the liquidity requirements without having to incur costs is to look at other short-term and other long-term fixed income investment options available in the market.

Fixed Income instruments performance over the last 10 years

As you can see in the table above, for short-term investments, one of the best instruments is overnight/liquid funds where one can invest even for one day. The redemption process is also very convenient, and one can have his money back in a day notice and with almost the same level of safety.

For long term investments, PPF and NSC being backed by the government are the safest options with decent returns but relatively higher lock in period. Hence, FDs are not the only option available to risk averse investors, and they can also consider investing in other fixed income instruments. They can carefully weigh the pros and cons of each of them and choose their investments basis their unique requirements to fulfil their desired goals.

(By Vikas Khaitan, Co-founder and Partner, Fintrust Advisors LLP)

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