Interest Rate On FDs To Fall Further: This Is How You Can Still Get Decent Returns

The government's commitment to restoring Indian economy's health came to the vigil yesterday after FM Nirmala Sitharaman took to a slew of measures on Friday from withdrawal of surcharge on FPIs and domestic investors to easing of banking services to bank's agreement to pass on interest rate cut benefit to customers to motown revival measures. Also, she suggested that non-compliance by corporates on the CSR front will not be treated as criminal offence.

Talking specifically of the banking space, you as a depositor at the bank can face still more pressure with the falling of interest rates going ahead. As it is we have seen PSU banks cutting down interest rates on FDs twice in the month of August itself after the RBI's MPC reduced key repo rate by 35 basis points yet again on August 7 to 5.4% (taking the total rate cut so far to 110 basis points). SBI with effect from August 26 will offer lower return on FDs. A one-year fixed deposit (FD) with SBI will now earn 6.7% per annum, down from 6.8% earlier.

And if you happen to be a senior citizen who solely rely on FD interest income for meeting your day to day expense, you might be hit hard all the more due to a slew of steep reductions of FD rates in the last few months.

Also, not to forget the recent collection in equities by heavy numbers due to some unfavourable budget measures which led investor flows into more safer avenues such as FDs. The momentum has also been driven by weak corporate earnings for the quarter ended June.

So, what proactive steps you need to take to cushion your investments from lower returns. This is what we talk about in this story:

1. Lock in your surplus funds in FDs right away: As some of the conservative investors still solely rely on FDs being the safest investment avenue, you can lock in your surplus funds in FDs right away. This is because if you have been waiting for banks to hike FD rates again, the wait can get a little longer as it is only when the RBI reverses its interest rate cut cycle that deposit rates will move higher. Until then, move your funds from bank savings account to FD which can still fetch you a better return in comparison.

On August 23, 2019, SBI for its savings account with deposits over Rs. 1 lakh (linked to repo rate from May 1, 2019) has held interest rate steady at 3%. The decision to this effect was taken as if the current repo rate was taken into account, S/B accounts would fetch a very low return of just 2.65% (effective interest rate being 2.75% below repo rate). So, if you have a lower horizon of less than a year, bank FDs can still provide you with a return of 6.5-7% per annum.

2. Book FDs for 2 years to avoid reinvestment risk: Debt instruments such as FDs work well when you opt for a shorter tenure as a sudden reversal in interest rate cycle can benefit you. As it is from last few years, we have been witness to relatively shorter rate cycles. Also, you can opt for the 2 year tenure which helps to avoid reinvestment risk i.e. the lack of an opportunity to book or reinvest the amount the at the current rate.

3. Do not miss on FDs of Small Finance Banks: Small Finance Banks set up only recently were established to provide financial inclusion and these in order to strengthen their customer base are attracting them with a higher return on FDs. Say for example, Fincare Small Finance Bank on 21 months to 24 months deposit offer 8.75%, Jana Small Finance Bank offers 8.6% on 2-year FD while Suryoday for FD with maturity spanning over 1.5 year to 2 years offers 8.5% per annum.

But what you need to factor in here is that FDs at Small Finance Banks are exposed to an element of risk as there can be stability issues. So, you need to do a thorough research work and check on the bank's ratings to find out how secure would be your deposit with the bank. For a FD plan of less than 12 months tenure, CRISIL A1+ is the rating you should aim at while for higher tenures FAA or FAAA is the top-most rating.

Also, you can avoid putting all of your money intended to book FDs into Small Finance Banks as experts' advice to take just an exposure of up to 25% of the total amount to limit one's risk. Further there can be lack of transactional convenience at these newly set up banks, so always check for the location of these banks in your city, before applying.

4. Segregate your deposits across banks: It is better to be safe than sorry and as depositors are insured only up to Rs. 1 lakh for both principal and interest amount under the Deposit Insurance and Credit Guarantee Corporation of India (DICGC) scheme, you should consider splitting your FDs across banks. This is because for deciding this limit, sum of all the deposits across branches of the same bank are factored. Notably FDs at new banks such as Payments Banks and Small Finance Bank are also insured under the DICGC.

5. Corporate FDs can also be used to diversify one's FD portfolio: Herein opt for the FD with the highest rating of AAA and as experts hope that interest rate on these FDs to be revised lower as early as by the start of next month, you need to just get going and lock in your surplus funds and deploy them to corporates deposits. Names like Bajaj Finance, Shriram Transport Finance and PNB housing finance are some of the best options. For a 5-year FD Bajaj Finance offers 8.6% p.a.

It is worth mentioning that some of the corporate FDs have already seen a rate cut such asMahindra Finance, LIC Housing Finance, HDFC Limited which have seen a rate cut of 25-35 bps.

6. Tax-free bonds can be an another option if you have a longer time horizon Tax free bonds can also rescue you from falling interest rates as they offer a good yield to maturity because of the tax exemption on interest component. Also, the higher the tax slab you fall in, more will be the benefit. Also, similar to a bank, these are less likely to default being issued by government backed institutions. But note such an investment will be considered only when you do not liquidity issues, were looking for regular income which will be given to you as a regular coupon income and are in a higher tax slab rate.

So, if you are just a novice investor, stick by FDs and thereon work on upgrading your skills on more advanced investment options so that you can aim at bigger investment goals of beating inflation, compounding your return over the investment horizon and at the same time are also safe in protecting your capital money. These FDs kind of products do not help you create wealth, so slowy and gradually move up the investment ladder with may be debt products, first after the FDs can be liquid funds who provide benefits at par with FD. Thereafter you can consider investment in bank oriented funds.

The rate cut is now even more imminent with the dismal GDP numbers and government will nudge banks to pass lower rates to end consumer.

7. Debt funds: If you are looking at safety and still can afford some risk element, this fund category can be still more rewarding than FDs given the returns which are both inflation beating as well as tax efficient. Among the different fund options, accrual based or duration based funds will be much safer.

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