So what are your options now? First, you may go up the maturity curve because long-dated instruments offer higher rates to compensate for the higher interest rate risk. Second, you may go down the credit curve and give your money to riskier issuers. But do keep your tax liability in mind. Some products could offer high rates, but no tax benefits (such as corporate FDs), while others offer comparatively lower returns, but tax advantages (such as tax-free bonds).
We look at various options under these two routes to help you decide your fixed-income journey.
Going up the maturity curve
This means holding longer-dated debt. This type of debt tends to give higher yields to make it worthwhile for you to stay invested for the long term.
Employees’ Provident Fund (EPF): If you are a salaried individual, EPF is the low-risk option that is currently offering among the highest returns in the fixed-income space. EPF matures at age 58 and is open only to organized sector employees and entails a 12% deduction of your basic salary plus dearness allowance matched by a 12% contribution by the employer. The interest rate on EPF is linked to the performance of the investments and it is declared by the EPF Organization (EPFO) every year. This interest is tax-free.
So factor this in your debt allocation and if your goals lend themselves to a longer time horizon, you could actually increase your allocation to EPF through Voluntary Provident Fund (VPF). Note that VPF shares EPF’s interest rate and tax-free status. You can contribute up to 100% of your basic salary plus dearness allowance to VPF.
Public Provident Fund (PPF): For the non-salaried, PPF is a good option. It is a tax-exempt product (on contribution, interest rate earned and withdrawal giving it the exempt-exempt-exempt or EEE status) and is among products that give the highest interest rate at 7.1% per annum. However, you can only invest up to ₹1.5 lakh per year in PPF. The tenor is 15 years that you can extend by blocks of five years.
Sukanya Samriddhi Yojana: If you have up to two girl children, you can invest in this. It currently offers an interest rate of 7.6% per annum. This is an account that can be opened by the parents of a girl child under the age of 10. It has a tenor of 21 years and an investment limit of ₹1.5 lakh per annum. Contributions to it and the interest rate it pays are tax-free.
The two small savings schemes are highly recommended by financial planners as they are relatively risk-free and don’t have any volatility as they are not market-linked. Their interest rates are announced every quarter. However, they suffer from investment limits. This means going down the maturity curve chain for small savings products with lower tenor and lower yields.
National Savings Certificates (NSCs) and Kisan Vikas Patras (KVPs): These do not have investment limits. They are issued by the government and can be purchased from banks and post offices.
Currently, NSCs pay an interest rate of 6.8% per annum and have a five-year tenor. In NSCs, both the principal amount and interest earned are eligible for tax deduction under Section 80C of the Income-tax Act, 1961, up to ₹1.5 lakh per annum. You can invest higher amounts in NSCs but you will not get any tax benefit. The additional amount will be taxable at your income tax slab rate.
KVPs have an interest rate of 6.9% and a tenor of 10 years and four months. Interest earned in KVP is taxable at your slab rate.
Note that interest is paid on maturity in NSCs and KVPs and not on a monthly basis. “NSC and KVP are suited for highly conservative investors due to their government guarantees. They also work for those in low-tax brackets. This is because their interest is fully taxable," said Amol Joshi, founder, Plan Rupee Investment Services, a financial planning firm.
Term deposits: Banks have been cutting FD rates over the past two months at a rapid pace leaving few options on the table. “With current rates, FD investors will get real returns of less than 1%," said Joshi.
Within this universe, post office deposits have an edge. Unlike the ₹5 lakh guarantee on bank FDs, post office FDs are part of India’s small savings universe and are fully backed by the government. They are offered in maturities of one, two, three and five years at rates ranging from 5.5% for one year to 6.7% for five years.
The interest earned on term deposits is taxable at your slab rates. However a five-year deposit can be made under Section 80C with deduction benefit on the principal amount up to ₹1.5 lakh.
Going down the credit curve
Here are the options those willing to take some risk can consider.
Corporate FDs: Just like banks, companies can also issue FDs. However, corporate FDs carry a far higher risk of default. Corporate FDs are rated, so you can choose a AAA-rated corporate FD from a highly reputed company to reduce your risk. The rates are on the higher side. For example, HDFC Ltd is paying 6.93% on a 15-month FD. Bajaj Finserv is offering 7.4% on FDs of 12-23 months, and ICICI Home Finance is offering 7% on FDs of 12-24 months.
“You should look at corporate FDs for a small portion of your investment amount from marquee names. Don’t get tempted by higher rates in lesser known names in today’s economic scenario," said Sasikumar. Interest earned on corporate FDs is fully taxable at the slab rate.
Debt mutual funds: Mutual funds do not offer fixed rates of return. However, some categories such as liquid funds broadly track short-term yields in the economy, currently in the 5-6% range.
The covid-19-triggered slowdown and risky debt investments have darkened the investment case for debt funds. However, conservatively-run schemes in relatively low-risk categories such as liquid funds, corporate bond funds and banking and PSU debt funds can work as a reasonable alternative to the RBI bonds, depending on your risk appetite.
If held for longer than three years, capital gains on debt mutual funds also have a tax advantage. They get taxed at 20% and are given the benefit of indexation. For periods less than three years, gains are taxed at the slab rate.
“Investors can look at moving one notch down in the credit risk curve (take more risk) with corporate bond funds or banking and PSU debt funds," said Joshi. Corporate bond funds are required to invest at least 80% of their assets in debt rated AA+ and above, while banking and PSU debt companies must invest at least 80% of their assets in debt issued by public sector enterprises and banks. The Securities and Exchange Board of India (Sebi) has given such funds a temporary leeway to reduce these thresholds to 65%, but replace their debt with equally low-risk government debt.
Customers should strive for a balance rather than putting all their eggs in one basket. An approach that relies only on FDs and small savings may not be able to beat inflation. On the other hand, a complete credit risk approach can suffer heavily when papers are downgraded or when there’s a default.