Interest rates are facing a downward spiral, which is worrying those dependent on them to no end. A 25 basis point reduction by the Reserve Bank of India (RBI) has not helped matters. Bank interest rates are now hovering between six-seven per cent for different tenures. This has meant that over the past two-three years, their income has slid by 20-30 per cent. While inflation has moderated, various costs have scaled impressive peaks, which leaves little cheer for those dependent on income from fixed deposits (FDs).
What can these people do? Are there any alternatives available to them?
Senior citizens can invest in the Senior Citizens’ Savings Scheme (SCSS) for a tenure of five years, which can be extended by three years. At an interest rate of 8.3 per cent, currently, this looks attractive. It offers a quarterly interest that ensures regular income. However, there is a limit of Rs 15 lakh that a senior citizen can invest. Hence, the scheme is of limited utility.
The other option that is favoured by the public is Post Office MIS, which offers an interest of 7.6 per cent per annum. This is a five-year plan that offers a monthly income, which is taxable. The maximum investment by a person is capped at Rs 4.5 lakh, which means that a couple can invest up to Rs 9 lakh.
People have started investing in Public Provident Fund (PPF) purely from a returns perspective (currently at 7.9 per cent). An individual can invest Rs 1.5 lakh per annum in PPF. However, since PPF does not offer regular income or even liquidity, it would be unsuitable as an alternative to FDs. If regular income is not a consideration but decent returns are, then PPF is fine. The income is tax free. However, the amount that can be invested every year is capped.
The other option that people are considering these days is a debt mutual fund scheme. Debt mutual funds invest 100 per cent in fixed income instruments. There are different categories of debt mutual funds. Depending on the duration of one’s investment, one can invest in liquid, ultra short-term, short-term, medium-term, dynamic bond, corporate bond, debt hybrid, and income Funds, among others.
The fund manager would be investing in an appropriate basket of securities according to the mandate of the fund. Since even debt papers are traded, the NAV of the scheme changes on a daily basis and there is no fixed return promised in a debt fund. This is unnerving for some. However, debt funds would offer returns that mirror the market but have the potential to do better than an FD in raw returns. This is because of the availability of better and special products to the fund manager for subscription, better management of the mix of products by the fund manager, gaining from interest rate cycle through capital appreciation, managing the credit risk and encashing opportunities, among other things. Due to this, the schemes are able to generate between 0.5-1.5 per cent, or more, on a pre-tax basis as compared to a simple FD.
The other big attraction is that the income generated from the MF scheme is treated as capital gains. If the Debt MF scheme is held for 36 months or more, it is eligible for long-term capital gains tax treatment. In this scenario, indexation is possible and the effective tax comes to just about five per cent, which is way better than the regular 20 per cent or 30 per cent that one may be otherwise paying. This tax arbitrage also boosts the post-tax income.
One can set up a regular income through systematic withdrawal from a debt fund, ensuring a steady income stream. Hence, a debt fund offers better returns, good tax efficiency, and a scope to set up an income stream according to one's needs. Also, there is no limitation on the amount that one can invest in these schemes, which is a huge plus, especially for people who have a big corpus.
The author is the founder of Ladder7 Financial Advisories
Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.