By Varun Fatehpuria
As we move away from a low-interest rate regime, it’s also time that we recalibrated our expectations on interest earned on our savings bank account. Today, most banks – whether private or PSUs – are offering 3-4 % interest rate despite a significant hike in repo rates by the RBI. Repo rate is the rate at which the RBI lends money to commercial banks. And while banks are quick to pass the rate hikes to the borrowers, the same velocity is not quite seen for the depositors.
If we consider the inflation rate of 6%, we are effectively losing the purchasing power of our money by leaving it in a savings account.
However, nowadays there are better solutions for one’s short-term cash goals than what a savings/current account offers. One can consider investing in a mix of liquid, ultra-short term and arbitrage mutual funds depending on their risk appetite and time horizon. These funds offer the same benefits i.e., liquidity and capital preservation that a bank account offers while delivering significantly higher returns.
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Where do these funds invest?
When you deposit your money in a bank, your money is not sitting idle. The bank pools money from thousands of depositors like you and lends that forward to many different companies and individuals and earns interest on that. Similarly, these funds invest in securities like certificates of deposits (CDs), commercial papers (CPs), etc., issued by the companies and central/state governments. All these instruments are assigned a credit rating – a measure of the riskiness of the debt – and the funds typically only invest in institutions with the highest and best credit ratings.
Bank deposits up to Rs 5 lakh are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). Debt/Arbitrage mutual funds are investment products and thus are not covered by the same. Hence, they inherently carry a certain level of risk. However, the funds are able to successfully mitigate that by investing in first, the highest-quality assets like sovereign bonds, AAA-bonds issued by blue-chip companies with little probability of default; and second, in short-duration bonds (between one and six months) that are less exposed to any interest rate risk.
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This ensures that your money is safe and available to you when you need it.
Your money is of little use if you can’t get it when you require it. And therefore, the redemption requests for these funds are processed within 1-2 working days. With investing in mutual funds now completely online, the amount is transferred directly to your source bank account with a few clicks. You do not need to fill out any paperwork or visit a branch to get your money back.
The main advantage of investing in short-term debt/arbitrage funds is that their returns mirror and follow the movement of the repo rate. A hike in the repo rate is reflected in an increase in the returns of these funds. Currently, they have a yield-to-maturity of 6-7% – depending on the fund – which means that if you stay invested till the maturity (typically 1-3 months) you can expect to get returns close to that.
All the above reasons provide a compelling opportunity for you to look beyond your savings bank account and consider better, more-efficient investment products.
* Short-term debt/ arbitrage funds’ returns mirror and follow the repo rate’s movement
* Redemption requests for these funds are processed within 1-2 working days
* These funds invest in sovereign bonds, AAA-bonds of blue-chip firms & short-duration bonds
The writer is founder & CEO, Daulat