The Reserve Bank of India (RBI) recently cut its repo rate to six per cent. Bank fixed deposit (FD) rates have been declining for some time and the latest cut could soon be transmitted by banks to their FD rates. On July 31, State Bank of India (SBI), the country's largest bank, had reduced the rate on its savings deposit from four per cent to 3.5 per cent. In this falling-rate scenario, conservative fixed income investors and retirees, either in their 40s or post-60, need to rejig their investment strategies to stem the fall in their portfolio returns.
Will rates go further down? Experts don’t think interest rates are moving in a uni-directional manner and are slated to fall much further. The RBI had turned neutral in February, which meant it could move either way. Given how inflation and capital flows have panned out, it decided this was an opportune moment to offer some relief to the economy through a rate cut. But, the central bank remains concerned about the long-term inflation outlook and its responsibility of maintaining inflation at a steady four per cent. Pay hikes and loan waivers in states and this year’s low base mean adhering to this target could be a challenge in the future. “The RBI has used data flow to cut the repo rate once. But, the possibility of another rate cut this fiscal year looks fairly remote, unless things pan out differently and inflation falls sharply, which is unlikely. I think it will stay on hold for a while,” says Abheek Barua, chief economist, HDFC Bank.
SBI had cut its savings rate because it is flush with liquidity and credit growth has been weak. Again, this is not permanent.If the demand for money goes up, the bank could well hike its deposit rates again.
The bottom line is that investors should keep an eye on developments and not get excessively worried by talk of a falling interest scenario.
Options for conservative investors: If you are a diehard bank FD investor (and especially if you belong to a lower tax bracket), you should shop around for the best rates. Some banks still need to attract deposits and are, hence, offering higher rates. IDFC, RBL, City Union, YES, IndusInd, DCB, Karur Vysya and Dena are offering rates ranging from 7 to 7.5 for one to five-year tenures. These rates range from 7.50-8 per cent for senior citizens. However, you will only be able to avail of these rates if one of these banks is located near you.
Middle-aged investors saving for retirement should continue to rely on Employees’ Provident Fund (EPF) and Public Provident Fund (PPF). “The EPF with 8.65 per cent and the PPF with 7.8 per cent return remain the best options for conservative investors saving for retirement,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor. These returns are not taxed at withdrawal.
Investors in higher tax brackets could look at tax-free bonds. Unless a new issue comes, they might have to purchase these bonds from the secondary market, where these are trading at a yield of 5.9-6 per cent (tax-free, which means the pre-tax yield is around 8.5 per cent). By buying these bonds, you can lock into this yield for the long term. The eight per cent GoI bond is another option.
Investors with some risk appetite could consider parking their money in debt funds. Match your investment horizon with the type of fund you invest in. Those with a tenure of up to three months may invest in liquid funds; those investing for three months to one year could opt for ultra-short term debt funds; and those with a one-three year horizon for short-term debt funds. If you have a tenure of more than three years, consider dynamic bond funds. If debt funds are held for more than three years, they offer indexation benefit which reduces the tax incidence considerably. “Investors entering debt funds for the first time should stick to those that invest only in triple-A papers, so as to eliminate the risk of default or downgrade,” says Murthy Nagarajan, head-fixed income, Tata Asset Management. In any circumstance, avoid funds investing in below AA-minus papers. “Also avoid funds that are highly concentrated in certain papers within their portfolios,” adds Arnav Pandya, a Mumbai-based financial planner.
Middle-aged investors who have more than 10 years to retire should consider learning about equity mutual funds, and investing gradually in these. Use a qualified financial advisor to select quality funds and build the right portfolio. Invest with at least a five-year horizon in balanced and equity funds. Also, move initially into funds with a small equity component. “New investors should ideally start with monthly income plans, equity savings schemes, balance advantage funds and then balanced funds. Only as they get comfortable should they move into large-, multi-, mid- and small-cap funds in that order," says Nilesh Shah, managing director, Kotak Mutual Fund.
Options for senior citizens: If you are a senior citizen, your corpus needs to generate a steady income for you in retirement. One good product is the Senior Citizens’ Savings Scheme (SCSS), where the return is attractive at 8.3 per cent. You can invest a maximum of Rs 15 lakh (Rs 30 lakh along with spouse) in it for five years. Your investment also qualifies for Section 80C benefit.
The newly-launched Pradhan Mantri Vaya Vandana Yojana (PMVVY) is another good option. It offers a guaranteed return of eight per cent monthly (effective rate of 8.30 per cent annually) for 10 years. The only dampener is that the maximum amount you can invest has been capped at Rs 7.5 lakh. Nonetheless, do use this product to the hilt.
Another fixed-income product you may consider is the Post Office Monthly Income Scheme, but here the interest rate has fallen to 7.5 per cent. A single person can invest Rs 4.5 lakh in this instrument and Rs 9 lakh along with the spouse. Returns from all these three instruments are added to your income and taxed at the marginal tax rate.