FDs are so old-world, but don't write them off, yet



Financial advisers say it would be wrong to avoid fixed deposits as an old-school instrument

With markets getting efficient over time, interest rates falling to record lows and investors turning more tech-savvy and open to experimentation, bank fixed deposits have been losing appeal over the past few years. According to a Mint report, bank deposits slumped nearly 10% between 23 April and 21 May this year. At the same time, equity mutual funds saw net inflows of about 9,230 crore in May. Although the inflow into equity schemes halved in June, the continued investment suggests that investors are looking at avenues for higher returns despite increased risks.

One key factor behind this migration is low returns from bank deposits. From 8-8.5% returns till a few years ago, one-year fixed deposits from State Bank of India (SBI) are delivering 5-5.50% returns today. The low real return thanks to higher inflation rate is another reason behind the exodus from bank deposits. The headline consumer price index (CPI) inflation in June remained steady at 6.26%. According to Emkay Global Financial Services Ltd, inflation might have peaked, but is likely to remain elevated.

With inflation at higher levels, the real returns from bank fixed deposits are expected to take a further hit.

With increased levels of awareness, digital adoption and product innovation over the years, investors—especially millennials—have started avoiding bank fixed deposits. However, financial advisers say it would be wrong to completely avoid this old-school instrument.

“If FD investors are moving to debt mutual funds, to some extent it is fine. If investors are moving to equity or hybrid funds, then this is not a great strategy at all. These are two different asset classes. Risk and return potential are different, volatility is very high in the case of equity. It would be wrong to shift from FDs to equity-oriented mutual funds based only on returns," said Suresh Sadagopan, founder, Ladder7 Financial Advisories and a Sebi-registered investment adviser (Sebi-RIA).

In terms of shift to debt funds, these funds also cannot give substantially higher returns than the current interest rates in the market. According to Sadagopan, debt mutual funds today are giving similar returns to a bank FD, which is in the range of 5.5-6%.

Nishith Baldevdas, founder of Shree Financial and a Sebi-RIA, said that predominantly investors are moving out of FDs because they are finding that post-tax returns are low. “When interest rates go up, returns from debt funds might turn negative. This is the biggest mistake investors are making. In debt asset class, an FD pays better compared with liquid or ultra-short funds," he said.

The average return from liquid funds over the past one year is at 3.17%, and 3.77% in the case of ultra-short funds.

“Most people don’t understand the risk of debt. People are moving out of FDs because of low rates; but FD returns are guaranteed. In other asset classes, returns are not guaranteed," added Baldevdas.

Another factor where bank FDs score over mutual funds is building an emergency corpus. Bank deposits can be liquidated at any point of time. When you redeem your mutual fund, you will typically receive your unit’s funds within one to five working days.

One big shortcoming of bank FDs are their low post-tax returns. However, investors should keep in mind that while bank FDs may not work for investors in the higher tax bracket, those in the 0-10% bracket may find FDs appealing.

“For investors in higher income tax slabs, FDs may not be the appropriate instrument, because a majority may not be senior citizens and don’t require a stable income. In terms of overall asset allocation, debt mutual funds might work better for them as they don’t require regular income unlike senior citizens or retirees," said Sadagopan.

Therefore, in lower tax brackets, the post-tax returns on FDs are more competitive against debt funds.

According to experts, in terms of short-term goals and emergencies, there is no alternative to bank FDs. “Even at, say, 2am, you can take money out of an FD, there is no such option in mutual funds," Baldevdas said.

Financial advisers say senior citizens who are retired should allocate to the debt asset class in such a manner that the fixed portion must be guaranteed. They should do this after understanding their cash flows and considering a safety bucket. Over and above this, the retirees can take up schemes such as postal schemes, and then move into dynamic allocation and equity, later.

While FDs provide risk-free returns, experts also feel that low-yield bank FDs work only for conservative investors. “If millennials are looking for higher fixed returns, they can look at government schemes such as Post Office Monthly Income Scheme. Please note, however, that they are fully taxable," said Mrin Agarwal, founder, Finsafe India Pvt. Ltd.

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