By Jimmy Patel
The successive policy repo rate cuts by the Reserve Bank of India (RBI) since 2019 to support growth has left sections of the society nervous. The rate cuts are good news for the borrowers, but for depositors it means lower interest rates on their bank deposits.
Bank Fixed Deposit (FD) rates have reduced considerably: from 8-10% per annum until a few years ago, interest rates offered on bank FDs today are around 5-7% per annum.
Table 1: Term Deposit (FD) rates applicable for deposits below Rs 2 crore
|Banks||FD Interest Rate (per annum)||Senior Citizen FD Interest Rate (per annum)|
|Public Sector Banks|
|State Bank of India||2.90% – 5.40%||3.40% – 6.20%|
|Punjab National Bank||3.00% – 5.30%||3.75% – 6.05%|
|Bank of Baroda||2.90% – 5.30%||3.40% – 6.30%|
|Canara Bank||3.00% – 5.30%||3.00% – 5.80%|
|Bank of India||3.25% – 5.25%||3.25% – 6.00%|
|ICICI Bank||2.50% -5.50%||3.00% – 6.30%|
|HDFC Bank||2.50% – 5.50%||3.00% – 6.25%|
|Axis Bank||2.50% – 5.50%||2.50% – 6.00%|
|Kotak Mahindra Bank||2.50% – 4.50%||3.00% – 5.00%|
|IDFC First Bank||3.00% – 6.75%||3.50% – 7.25%|
Interest rate range for a tenure of 7-45 days to 5-10 years. All figures in % per annum
(Source: Respective Bank website)Such rates are proving rather unsettling and unsupportive particularly for senior citizens, who predominantly invest in bank FDs. After adjusting for inflation, the real returns are paltry.
Some smaller banks may be offering high interest rate on deposits, but it is not worthwhile taking the extra and uncalculated risk for few additional basis points. In fact, in the current times of COVID-19 given that systemic credit risk is amplifying, NPAs of banks are likely to rise. Do not assume hard-earned money in bank deposits to be safe, especially with smaller banks.
What is a better investment option then?
Consider allocating an appropriate portion of your corpus in a pure Liquid Fund.
The primary objective of a liquid fund is to provide optimal returns with low-to-moderate levels of risk and high liquidity through judicious investments in money market and debt instruments.
As per SEBI’s mutual fund categorization and rationalization norms, a liquid fund invests in debt and money market securities with a maturity of up to 91 days. The investors’ money is parked in market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills and so on. A Liquid Fund usually benchmarks its performance against the Crisil Liquid Fund Index.
A pure liquid fund is one of the low risk fund in the debt fund category. For this reason, a pure liquid fund is placed at the lower end (almost at the bottom) of the risk-returns spectrum.
If you have a low-risk appetite, prefer safety and liquidity to returns, wish to park money for the short-term, for contingency purpose, and/or to tactically shift money from high risk investment instruments to offset the volatility, a pure Liquid Fund would be a suitable for you.
Table: Liquid Funds Return across Time Periods
|Absolute (%)||CAGR (%)|
|6 Months||1 Year||2 Years||3 Years||5 Years||7 Years|
|Category Average Returns||2.2||5.0||6.0||6.3||6.7||7.5|
|Benchmark: Crisil Liquid Fund Index||2.5||5.5||6.5||6.7||6.9||7.6|
Data as of August 11, 2020
Point-to-point returns taken calculated using Direct Plan-Growth option. For a period up to 1 year, the returns are absolute, while compounded annualized for periods over a year. PAST PERFORMANCE MAY OR MAY NOT BE SUSTAINED IN FUTURE
(Source: ACE MF; )A liquid fund could earn slightly higher than the interest earned on a bank FD with low market risks. But keep in mind that going by the investment mandate, the fund managers of liquid funds are expected to prioritize the preservation of capital rather than maximizing returns. The returns of a liquid fund should closely correspond with the Crisil Liquid Fund index. If a liquid fund is delivering higher returns than the category average, peep into its portfolio to check if it holds debt papers exposing you to any undue credit risk or engaging in yield hunting.
With the help of a qualified financial advisor, you should evaluate:
· Is the quality of the securities held in the portfolio good?
· What if the rating assigned to particular debt paper slips; does the fund house have adequate risk management measures in place in such a case?
· the ‘liquidity’ aspects of the fund?
Investors would be better off going with only a pure liquid fund that does not have exposure to private issuers and invests only in Government Securities, Treasury Bills and AAA/A1+ rated Public Sector Undertakings (PSUs).
Understanding the investment processes and systems, the internal risk assessment framework at the fund house, and its ideologies help when one approaches a liquid fund.
As for tax implications of investing liquid funds, there is a relative advantage over bank fixed deposits. Units of a Liquid Fund held for a period over 36 months before selling them, are considered long-term and taxed @20% Long Term Capital Gain (LTCG) Tax with indexation benefit. However, if units of a Liquid Fund are held for 36 months or less, it is termed as Short Term Capital Gain (STCG) and taxed as per the marginal rate of tax – that is, as per one’s tax slab.
When you invest in a liquid fund, ideally align the investment tenure as per your liquidity needs.
(Jimmy Patel is the MD & CEO, Quantum Mutual Fund.)