Need regular income? There are better options to FD

In the last post I had said that we will need to look at a category separately, those who are retired or otherwise and seek regular income for their expenses. Most of these people keep their money in Bank FD’s. Some look at slightly riskier options of corporate FD or NCD in order to earn a little more interest. In this post I will examine options such people have in looking at other instruments.

Now, to give some structure to the discussions let us assume the investor will need 6 lacs per year for his expenses, given that he has a home to stay in and his children being settled financially. If he has 1 crore out of his retirement proceeds or other assets, one option will be to put it in FD. As a senior citizen he will probably get a rate of 7.5 % per year today. So he gets 7.5 lacs in a year which will be good enough for his expenses. As a senior citizen his taxes on this will be 60000 Rs, can also get reduced if he invests in 80 C instruments, medical insurance etc.

So, if this seems to work, why should they just not do it? Firstly, there is no guarantee that the interest rates will not go down further. Secondly, inflation is always going to be a factor and even with a 6 % inflation the costs will double in 12 years time. Thirdly, as no one can predict the life span it will always be better to have some growth factored into your portfolio. In the FD scenario there is absolutely no growth. Fourthly, with increasing expenses you will soon be eating into the capital and may reach a situation that you run out of money long before your passing away.

Let me outline some alternatives with the pros and cons that the investor can look at. I will not go into too much theory here, those are all available in my blog or in the public domain. 

  • Keep the money in the dividend option of MIP funds. These funds mostly give a monthly dividend which will be tax free in your hands. However, there is a Dividend Distribution Tax the fund house has to pay.
  • You can also use the Growth option of MIP and redeem to the extent you need money every month. It will be better to do this after your investment has crossed 3 years as you can get the benefit of LTCG indexation.
  • If you have planned earlier then set up 3 year FMP. As they mature you can use the capital gains for your regular expenses and reinvest the Principal amount in other FMP. With the rates coming down you may want to invest in dual advantage FMP to get incrementally better returns, though with some element of risk.
  • You can put your money in ICICI Balanced Advantage or similar funds which allow selection of dividend in a defined manner. At a rate of 9 % your returns will be adequate for your expenses and dividends are tax free in your hands. However, as the equity exposure is significant here, the element of risk is also high.
  • The above strategy can be also used with Equity Savings Funds, Dynamic Funds or even pure Equity funds as long as you are able to afford the risk.
  • Finally, you can of course try a combination of the above.

How do I invest myself ? Well, for several years now I have no Fixed income product except for Post Office MIS and that was done with a specific purpose in mind. My alternatives have been in FMP, Balanced funds, Gilt funds, MIP, Equity Savings Funds and so on.  For the debt space, I feel I have got a good balance between decent returns and good tax efficiency.

I will write in some details on these later on and also share a couple of real life case studies.

Do you still invest in Fixed deposits? Need to change

As the readership of my blog and also the Facebook group has increased, I get a lot of queries from readers on how should they go about making a financial plan and their investments. There are also many requests from my friends and relatives in terms of reviewing their current investments and make suggestions on the same.

One of the things which surprises me every time I see it is the continued fascination that many investors still retain for Fixed deposits. Yes, I understand that they are perceived to be safe and highly liquid but from an overall financial perspective they really do not make any sense at all. Let me give you a few examples to illustrate my point.

  • A senior IT executive working in an MNC from Bangalore, had more than 30 lacs in FD. He said he was keeping it handy for his daughter’s higher education or marriage as the case may be.
  • Another IT professional from Kolkata working in TCS was having more than 20 lacs in FD. He said it was a combination of Emergency and contingency fund.
  • A cousin of mine, who is a Doctor with a private practice, recently approached me for suggestions on how he should invest 35 lacs that he got from FD maturity.

Note that these are people who are well educated, see TV a fair amount, read financial and other newspapers and are exposed to various financial blogs. If despite these they are investing in FD as a main channel then one can well imagine what most other investors from small towns or villages are doing. So while the Mutual fund SIP figures have greatly grown, the number of investors in FD and the amount of money they have in these deposits are still a mind boggling number.

But why am I saying that you should avoid FD in the main? Note that I have no issues if you have some 2-3 lacs in FD for Emergency purposes, though even that is not strictly necessary. Let me take the case of my cousin who had 35 lacs in FD till June of this year. 

  • The older FDs were at a higher interest rate so he was getting 9 % interest on them. 
  • His annual earning out of the 35 lacs was 3.15 lacs. All of this was taxable at 30 % as his other income is significantly more than 10 lacs.
  • The effective return was therefore only 6.3 %.

When the older FDs matured his banker told him that the best possible rates were 6.9 % in his bank. That would mean an effective rate of less than 5 %. It finally dawned on my cousin that it was really against common sense to renew the FDs. Even though he was told by his banker that other options are risky, he stuck to his guns about the renewal.

Are you like any of these examples listed above? Do you have a lot of money in FD and are paying taxes on the interest earned? If you are not paying taxes it is worse as the IT authorities are keeping a very close watch on all the FDs, even where a Form 15H or 15G has been submitted.

I think all readers are convinced by now that FD is really not a good idea. But the natural question then is, what do we invest in then? Will it be safe? What about liquidity? There are fortunately good answers to all these questions. I will write about it in the next post.


Debt investments which have worked well for me lately

As many of my readers will know well by now, I am a great advocate of the 3 portfolio strategy with Debt, Stocks and MF each having an important place. Of these, stocks and MF are typically for the long term and something I will normally not redeem in the next decade at least and maybe even later. Debt is different – in my FI state I depend on it for passive income and use some of this for my regular expenditure. 

One of the obvious approaches in debt investments is to understand the interest rate cycle and try to lock investments for a possible longer term, in order to maximise your interest earning out of these. While there is a bit of luck and speculation involved in this, if you are following the economy properly, it is possible to get these signals correct more often than not. A few of the situations in the past years which has really stood me in good stead are as follows:-

  • I normally put some amount as FD for my parents so that they get a monthly amount to supplement their income. I consolidated a larger amount in 2015 and locked it in for 3 years at a rate of 9.5 %. Current rates are 7.5 % only.
  • Despite several people advising me against it, I went ahead and invested in a big manner in the Tax free bonds of 2013-2014. The rates were close to 9 % and today it gives me an interest to meet nearly 25 % of my annual expenditure needs.
  • Our earlier POMIS matured in December 2015 with a rate of 8 %. I reinvested 9 lacs in a joint account with my wife at a rate of 8.4 %. Today the rate is 7.5 % or so.
  • In the 2013-2015 period I rolled over most of my FMP schemes as the rates of interest were favourable and it made sense to lock these in further. 
  • I also invested fresh into many FMP schemes as it seemed a good idea to have investments which locked into government papers at the then prevailing rates.
  • I continued my investments in PPF even though the rates kept coming down based on the alignment of Small savings schemes to the market rates. The EEE nature of it plus the possibility of a rate increase when the cycle reverses make it worthwhile.

While all of these were great till 2015 or so, since the last year, with the rates going down steadily with each RBI policy, Debt instruments have become more of a challenge. For all the instruments that are maturing today, one needs to look into alternatives that will give decent returns compared to a pure debt product.

In the meantime however, I am quite happy with the above decisions I had made. The best of them were definitely the investment in Tax free bonds.

How should you invest in Debt instruments now

While the current economic and business scenario is rather worrying for most investors, there are also opportunities that present themselves in the current context. If you look at your Debt allocation now, you may be worried about what you should be doing about the low returns that are already there and will possibly get far worse. 

Let us see what is likely to happen in the different types of debt instruments, based on the current situation and what you can do about it:-

  • There will be a secular reduction in interest rates and we will probably get back to the 2004-2005 situation. The one difference from there will be that the rates may not rise again the way it did at that time.
  • Assuming the rates are going to be staying here or get lower in the near future, it makes a great deal of sense to lock in investments now. Look at the ubiquitous FD, Post office MIS or Dynamic Bond funds.
  • Capital protection plans will be a good idea now, look at available schemes from good fund houses and select ones with 3-5 years duration.
  • FMP investment may also be a good idea but make sure you do it in the next month or so and be clear about the return expectations.
  • If you are looking at Debt MF, try the Duration funds with a time frame of 3-5 years. At this point of time, do not go for funds with longer duration.
  • In the present context a return of 7 % or anything more will be quite good if you are going for pure debt.
  • Rates in PPF and SSY will reduce but these are long term instruments and therefore investors should continue with them.

Given that a fair amount of my portfolio is in Debt, what are my plans for it? Let me first say that in 2016 at least, the performance of Debt has actually been better than equity. Here is what I have and how I plan to deal with it:-

  • Tax free bonds give me an interest of 8.9 % now. Even though I am having handsome capital gains from it, I plan not to sell them and keep getting the interest.
  • PPF accounts for me and my wife – I plan to continue both and invest the maximum permitted in 2017 also.
  • My FMP plans have given me pretty good returns, in several cases over 10 %. The ones getting redeemed will need to be deployed elsewhere.
  • As of now regular FMP does not make much sense – I plan to go for Dual Advantage funds, Short duration Debt funds, Balanced funds or MIP.
  • In general, it will be a good idea to invest in instruments which are hybrid in nature and not just pure debt in the next one year.

How you deal with your money is something you have to decide – make sure you understand the entire landscape, listen to sensible advice and take the right decisions.

Reduction in rates – what should you do?

The human mind is essentially selfish and complains about anything and everything that even remotely affects its interest. The reduction in rates which were announced yesterday, brought this point home to me with a great deal of clarity. Anyone with a smattering a knowledge of economics and business would have known that such rate cuts were inevitable. Yest when the actual announcement came the Electronic media and social media treated this as a full scale catastrophe and even something that would cause ruination of the middle class. My advice to all such people will be – “Stop the scare mongering, wake up and smell the coffee.”

Why do I say that the interest rate reductions were inevitable and should have been something any reasonably intelligent investor should have anticipated? Consider the following indicators of the economy over the last 1 year and more:-

  • Inflation headline numbers have been coming down progressively and is roughly in line with the targets that the government had set. Yes, we can argue that the CPI figures do not reflect the real situation etc but those are the figures used in policy making by the government.
  • Based on the inflation numbers the RBI has already made several rate cuts and a couple of more cuts may be in the offing in 2016.
  • Deposit rates in the banks have already been reduced over the last year. SBI rates are below 7.5% even today and private banks are also not offering more than 8%.
  • Tax free bonds which were at 9% in earlier years were being offered at 7.69% at the higher end from all companies that brought them to the market this year.
  • Based on all of these, it would simply not have been possible for the government to continue the artificially high rates in the Small Savings Schemes. These rates have to be aligned to the real economy, the government cannot prop these up by subsidies.

Having understood this, let us now focus on what can be done. Firstly, at a conceptual level we simply have to understand that these rates will now get linked to the markets. So in the given context it is quite possible that there may well be a further downward revision in the rates over the next one year or so. However, as the inflation comes down the real rate of return will hopefully increase and therefore the investor is not necessarily any worse off. Secondly, it is not the responsibility of the government to prop up the rates artificially by subsidizing the interest rates. We must look at these products as something the government is selling and make our own decisions as to whether we want to invest in these or not.It is our money and our decision, there will be very little point in blaming the government if the rates continue to go lower because of the economy and business context.

For people who are retired and depend on these schemes and others for a regular income, they can lock in their money into POMIS and SCSS even now to avail of the higher rates of interest. Both the lock ins will be fairly long term at their age profile and therefore they must be sure about not needing the capital in an emergency situation. People having PPF can continue to withdraw from it, though the rates will be lower. For such people fresh investments can simply be the minimum to keep the account running.

What about the rest of the people who are having a debt portfolio, not with a view to earn a regular income but to grow it as part of retirement corpus in future. I an outlining overall strategies for a variety of instruments, choose your options based on your need and attitude.

  • PF is a must for all salaried people and they can additionally have PPF. Till the EEE structure of PPF undergoes a change this is the best debt product.
  • Professionals and business people should have PPF accounts for themselves and their spouses – try to contribute the maximum amount permitted.
  • People blessed with a daughter must contribute in SSY. Given the nature and purpose of the product SSY will always have a higher interest rate compared to other products.
  • Debt MF of the category Liquid funds and MIP do not make much sense now and are best avoided for most investors.
  • Short term debt funds are likely to have higher returns in the medium term due the interest rates declining further but they do represent some credit risk. Additionally with the rise in the Cost Inflation Index becoming tempered due to lower inflation numbers, some tax impact will be there even after indexation.
  • FMP will still be a good idea if you are OK with 7-8% returns, but the time window will probably be only the next 1 month or so.
  • Tax free bonds are probably now over for this year but, if NHAI does come up with one more scheme, definitely invest in it. For people in the 30% tax bracket, the pre tax yield is in double digits and no product gives you so much today. This is particularly applicable to people who have a need for regular income.
  • Avoid products like Hybrid funds and Gilt funds if you do not understand them.
  • Finally if you have some risk appetite go with Equity Saving funds and Arbitrage funds for some fresh investments.

In conclusion, while you do need to reassess your investments and maybe tinker with a few things, there is no need for large scale panic and significant overhaul of your portfolio.

In the next post I will outline my own strategies for tackling the current situation.

Post Office MIS – alternative to FD

One of the things that never ceases to surprise me is the number of people who invest in Fixed Deposits with Banks and other financial institutions. Given that the interest from FD is fully taxable and that the rates are always revised downwards at the slightest opportunity, they definitely are not financial instruments that are investor friendly. However, people continue to invest in these and the banks mint money out of such investors.

Look at the present situation on interest rates. The banks have been rather quick to reduce the interest rates and for most part you would be lucky to get 7.5% to 7.75% for an FD you are opening today. Yes, they do have better liquidity, compared to many other products, but with the current low rates plus tax-ability of interest it really makes little sense to open new FD now. I have written in other posts on why you should consider tax free bonds if FD is a chosen investment platform for you.

Interest rates on the Small savings schemes such as PPF and Post office schemes will also undergo a reduction but that has not happened yet. I was surprised to learn yesterday that you will still get 8.4% interest on a Post Office MIS deposit if you get it done this month. The rates will be revised to 8% from the next month. I think for all readers who are looking at regular income, this is a good window of opportunity that you can use.

I will not get into describing POMIS as it has been done several times in many websites. The current term is 5 years and I believe you can get the interest credited monthly to your bank account. Liquidity is an issue but as the maximum investment is 9 lacs for a joint account, you will really not be impacted too badly on this score. For people who are not looking to use the interest, you can reinvest this in a Recurring deposit of the post office. The returns will not be great but you will get a decent sum after 5 years.

You need to be clear on your objectives before you do this. Obviously this is not a substitute for equity investments and should not be compared to such. This is purely a debt product and ideally a replacement for FD. I would also think that with the LTCG indexation becoming less potent with reduced inflation trends, this may even become comparable to debt fund instruments. PPF of course remains the chosen instrument due to the tax benefits that it offers but the term and liquidity will be a deterrent for many investors who are in their Forties and looking for a debt product to generate regular income.

So, if you are looking at such a product POMIS may well fit your bill. Remember, interest rates will go down and in another year you may be feeling good about the 8.4% interest when banks will barely offer 7%.

However, hurry on if you are interested – the rates will reduce from January.

PPF – what should be the strategy now?

Readers who have been with the blog since it’s inception will know that PPF is one of my favorite debt instruments. New readers may want to read the post on Why you must invest in PPF. As this post attracted a lot of feedback and comments, I had to do A follow-up post on PPF. Finally as readers wanted to know how I had used PPF for my own financial planning, I did the final post on PPF – A personal perspective. Now several people have asked me what is likely to happen to the PPF rates in the current interest rate regime and whether investing in it is still a good idea or not.

Before we get to the strategies of how to deal with PPF, let us first look at the historical rates of PPF over the last 30 years. It will be interesting to see that, in general, PPF rates have tended to be sticky and except for a brief period when the NDA government tried to link it to prevailing interest rates in the market, changes have been fairly rare. Look at the data:-

  • Between 1986 and 2000 the rate was fixed at 12 %
  • Between 2000 and 2003 it went down every year and dropped from 11 % to 8 %
  • Between 2003 and 2011 the rate remained at 8 %
  • Since 2011 the rates have not changed much and the current rate is 8.7 %

It is important to note that with the RBI reducing rates sharply of late and recommending that the small savings rate be bought in line with the bank FD rates, a change in the PPF rates is imminent. Politically the NDA formation believes in aligning rates of such instruments to the market rates, as they demonstrated the previous time. I fully expect the rates to come down to 8 % shortly and maybe even 7.5 % in the next budget.

So what should a new investor do now? I believe that despite the rate cuts that will definitely happen, PPF remains the best debt instrument that you can invest in due to the EEE tax treatment that it gives you. Remember that you are getting only about 7.5 % from Bank FD and and after taxes it will only be a little more than 5 %, if you are in the highest tax bracket. You can invest in debt funds where the returns will improve with falling rates, but remember that with lowered inflation the cost inflation index will also increase less and the effective taxation of LTCG in debt funds may increase. Also, PPF is a long term instrument that builds investment discipline. But most importantly, over a period of time it builds you a suitable corpus that you can tap into at the time of your goals. should the time not be a right one for redemption of equities due to the markets doing badly. This is really the biggest risk in equity investment and PPF gives you a cover for it. My suggestion to all new investors will therefore still be to open a PPF account as early as they can and maximize their contribution there.

As far as existing investors are concerned, the choice is really simple. You should simply continue investing in it without worrying too much about the rates. You are doing this as part of a financial plan and need to stick with it. In the long term these changes in interest rates will keep happening and, despite the inevitable lower returns, PPF remains the most attractive instrument for the reasons mentioned earlier in the post.

In summary, do not get flustered by the coming rate changes of PPF to 8 % or even 7.5 %. Continue with it if you are an existing investor and open a PPF account now if you do not have one yet. You will never regret it, I have not in 21 years.

The changing landscape of debt investments

While all the noise and excitement is normally about the stock markets, I think it will be fair to say that most investors in India historically have always depended on debt for their short and long term investments. Whether you look at the number of investors or at the financial assets invested, this conclusion is an inescapable one. Even for investors focused on equity, the almost automatic investments in FD, RD, PPF / NSC and of course PF is a reality. This is also a good thing as I am a staunch believer in having a solid bedrock of debt investments for giving stability to any portfolio.

In the present investment climate of India, the significant changes that are happening to the debt instruments and their potential returns have almost gone unnoticed. It is important to understand the changes to the landscape and more importantly, what will be the impact on the investors who are investing primarily in debt instruments. Before we look at the various classes of instruments, we need to understand the main reasons for the changing scenario.

As most of us know, returns from debt instruments have always been closely linked to the prevailing inflation rates in the country. Obviously, if the inflation is high the returns from such instruments also needed to be high, in order to remain attractive for people to invest in them. While inflation figures and interest rates have fluctuated over the last few decades, in general they have remained high. I remember the PPF rates used to be 12 % when I started investing in it more than 20 years back and went down to 8 % at it’s lowest point. Interestingly our financial institutions are quicker in lowering rates when needed and quite sluggish in raising it when the inflation gets higher.

Now all high inflation economies will get control over inflation as time goes by. Developed nations have lower inflation and going forward it is quite possible that we will be looking at inflation rates lower than 5 % before long. As the RBI Governor has signaled, it is going to work in closer coordination with the government on the policy rates. This essentially means the returns from debt instruments are going to change. What is more, with inflation being tamed, the changes in the returns may well be more permanent in nature than what we have seen earlier.

Bank FD s are always the first product to have the rates revised and this has already happened. Most banks are offering rates lower than 7.5 % now and even for senior citizens the highest rates available is 8.4 %. My parents have some FD s started a year back and they were getting 9.5 % in those. It is quite possible that over the next year, as policy rates go even lower with inflation declining, the FD rates will drop to below 7 %. This will be quite significant as I cannot remember the last time when these rates were below 7 %.

The other important impact will of course, be on the rates of the small savings schemes such as PPF , POMIS etc. The RBI has recommended that returns from such schemes be aligned to the bank interest rates. While this will be politically a tough thing to carry out immediately, over a period of time this conclusion is an inevitable one. The PF rates again will quite possibly be revised downwards, though even here it will be a difficult decision to implement.

What about debt mutual funds? Well here, the returns impact will depend on the type of funds we are talking about. Liquid funds and MIP etc will have lower returns. Investing in FMP seems to have very little point now. Gilt funds and other debt funds will have higher returns in a declining interest rate cycle and they can be invested in. However, with lower inflation we will also have a dampening effect on the Cost Inflation Index. This will essentially mean that the effective taxation on the capital gains will be more when you redeem your debt funds. This is too complex to explain in the context of this post, I hope to write a post on this later in the week.

The above would have shown you that there aren’t a whole lot of options as far as decent returns from debt instruments are  concerned. What should be the debt strategy then? Let me write about this in my next post.

How I plan to invest in current rate regime

Things can really change first in the investment world and unless we are monitoring our investments for these changes we can well be caught unawares. This happened to me recently and had led me to look at some changes in the way I operate with my investments. As part of my emergency fund, I had a small investment in a Liquid fund now for over 3 years. In the beginning the IRR used to be around 10 % and it came down to something like 9 % in 2015 first half. This week when I looked at it, post the rate cuts, I saw that the IRR was only 7.85 %. I have of course, redeemed the fund now.

Fortunately, the price paid for my negligent attitude was not high in this case and it was a good lesson learnt. It also set me thinking as to what will be the effect of the interest rate changes on my investments and whether there is a need to revisit some of my investment decisions made earlier. One thing is clear – we are not looking at a just one-off rate cut here, there is every possibility that we are in the beginning of a low inflation, low interest rate cycle. This will definitely have an impact on my own situation in terms of my current passive income, my current investments and my future needs.

Let us see how each of these are likely to be affected:-

  1. My passive income is made up of interest from tax free bonds, rental income, capital gains from debt funds (mostly FMP) and dividends from stocks/MF.
  2. Out of these the capital gains from debt funds can get affected positively for debt funds with maturity periods of more than 3 years as interest rates decline. The others including FMP will really be immune to the rate changes.
  3. If I take my retirement to be 8 years away, it is likely that the level of inflation will reduce and this will hopefully mean that I need a lower corpus to retire with. However, my policy has always been to assume a zero rate of real returns in the post retirement period. With this conservative approach in place, the retirement corpus I look at is pretty much the same for all levels of inflation.
  4. As far as my investments go, there will be serious implications there, mainly in the following areas:-
    1. The PPF rates will decline significantly to 8 % or less and this will impact my corpus to an extent.
    2. I have some investments in debt funds, other than the FMP variety. These will have lower returns for the Liquid and short term funds and a slightly higher return for the longer term funds.
    3. The FMP returns will be largely unchanged for the ones which I will redeem at maturity. For the few which I need to roll over because of tax purposes, the returns will definitely get lower.
    4. Equity performance should generally improve over this year and the next few years.

Based on the above, the following are the actions I will take on my investments:-

  • Keep my investments in PPF going on, even at lower rates this is going to be one of the better instruments.
  • Redeem all Liquid and short term debt funds, returns from these will get progressively worse with time.
  • Not invest in any future FMP as it does not make sense any longer. Any redemption from existing FMP, I plan to put the capital amount in longer term debt funds and/or Arbitrage funds.
  • As I said before, for MF investments I will stop my standard SIP and look at targeted one-time investments, which will largely be done in an overall manner.
  • As money becomes available from debt redemption, I plan to keep investing more in equity over a period of time.
  • In the above scenario, while the overall returns on my portfolio can get lower, my cash availability will be high. I am therefore looking at going on a vacation to South Africa next year and hopefully pay for my daughter’s MBA from my own resources, should she be getting into a good institute.

I suggest you do this exercise for yourself and see how your investments are likely to get affected and therefore, what investment decisions and actions you need to take. Remember, this can very well be the beginning of a different cycle in our economy and business. Changes are absolutely required, only question is what and how.

In the next post, I will write on the outlook of medium and longer term inflation and how it can affect each one of us.