In the last post I wrote about why FD as an investment is not at all a suitable one. It offers low returns and is clearly not tax efficient. The natural question therefore is, which are the investments to replace traditional bank FD? In this post I will try to answer the same.
Let us first look at why do people invest in FD. There can be many reasons but 3 of them are the most common ones:-
- Many people simply do not know of any options for savings and think this is a safe way which will also earn some returns.
- Some investors look at FDs as a good place for an Emergency fund and also for any goal that may be coming up in the next 1-5 years.
- Retired people and others who want a regular source of income keep their money invested in FD for the longer term.
In this post I will deal with the first two as the last one is more complex in nature and deserves to be dealt with separately.
For the first category of people, if they are able to keep the money for long term, my recommendation will be PPF. The returns here are more than FD today and they are tax free. Moreover you get 80 C benefits with PPF, so if you have not exhausted your 1.5 lac limit through other means, this is a great benefit. Also, though PPF is for a 15 year term, you can make withdrawals after 6 years. Finally, if you start early, this will be a great backup to your MF redemption, in the years which are not good for equity.
What if you do not want a long term product such as PPF? Well, one option can be Arbitrage funds which will probably give you returns of around 7 %. While this is pretty much the same as FD, the tax treatment is much better as you will not be paying any taxes on the capital gains after one year. You can therefore park your money here and redeem it in a tax free manner for any needs in an ongoing basis. Arbitrage funds are also quite risk free as far as your capital is concerned, unlike equity funds.
Regular Debt funds or FMP, MIP etc will work if your time frame is at least 3 years. This is the time you need to keep your money to get indexation benefits for LTCG. Note here that with the Cost Inflation Index ( CII ) being dampened due to lower inflation numbers, you will still need to pay some taxes but this would be on a much lower scale. Also, as the interest rates will go up, Debt funds and MIP are likely to have a lower return. We are pretty much at the bottom of the cycle and rates will go up in the next 1-2 years. Finally MIP will do very well if equities are doing well but therein lies the risk too.
In conclusion for the first category of people, use the following strategies:-
- If you are OK with a little risk go for MIP and Debt funds.
- If you are having lower risk taking ability but can wait 3 years or more go for FMP. Here too you can look at Dual Advantage FMP if some risk is all right.
- In case you do not have 3 years and are looking at moderate but steady returns, look at Arbitrage funds.
- If you just want to save and are not going to need the money for long, look at PPF.
What about category 2 people? Many financial planners will advise you to withdraw from equity and part the money in debt some 3 years before your goal etc. I have never found any sense in this as you might really be losing out on growth by such actions. At the same time being purely in equity is not a good idea either. You need to take some middle path which balances the needs of both growth and safety.
- Higher risk takers can try Equity Savings Funds or Balanced Funds.
- Moderate risk takers can try MIP, Dual Advantage FMP, Debt funds
- Risk averse investors can try FMP, Liquid funds, Arbitrage funds
Note here that the higher risk options are more suited to 3 years plus time frame.
So, there you have it. Now that you know what to do with your money which is in bank FD’s, go ahead and stop those. You will soon thank me for having written this post !!