Most people believe fixed deposits to be the safest investment possible as its value never go down, there is no perceived risk of bank defaulting on payments and you can do FD online just on click of few buttons.
But have you realized that investing in fixed deposit might be making some of you poorer. I am not kidding. I would throw you some numbers to prove my point.
But as with any financial calculation, here are some assumptions.
We take inflation as 7.5% per annum. In case you are not aware of inflation, it means that @ 7.5%, a product which was available for Rs. 100 last year, it now costs Rs. 107.5 i.e. 7.5% expensive than last year.
The table below shows the annual post tax return and inflation adjusted return for FD with interest rates of 8.75%, 9.00%, 9.5% and 10%.
The cells where inflation adjusted return comes out negative is shaded in red. These are people who are losing money year on year on Fixed Deposits due to inflation and higher taxes payout.
For e.g. if you are in 30% tax bracket, you need to invest in an FD offering at least 10% to get positive inflation adjusted return.
What should you do?
I am not sure how many of you knew the above fact but conveniently ignored it, but if you are looking for alternatives to FD, here are some options.
Debt Funds – if you invest in debt funds the returns might be similar to fixed deposits but the tax treatment is different. In case you redeem debt funds after three year, the gains are treated as long term capital gains and taxed accordingly. For less than 3 years the gains are treated as short term capital gains and the taxation is similar to that of FD.
You can get more details on Parking Short Term Money – Bank Fixed Deposit or Liquid Fund or Savings bank Account?
Also Read: Tax on Equity and Debt Mutual Funds
FMPs (Fixed Maturity Plans) – FMPs are close ended debt mutual funds. These are of varying tenures like three months, six months, one and two years and rarely for three years. These schemes portfolio consists of debt securities such as Government Securities, certificate of deposit and commercial papers of nearly the same maturity as the scheme. The returns are similar to FDs but they receive favorable tax treatment (for investment of more than 3 years) and suits people in higher tax bracket.
Savings Account – In certain circumstances, the best strategy is to leave your money in saving bank account. This strategy suits you if you satisfy following three conditions:
- You are in highest tax bracket of 30%
- The bank offers 7% interest on savings account and
- Total interest for the financial year in savings bank account is less than Rs 10,000.
The strategy works because budget 2012 introduced a new section 80TTA, according to which interest up to Rs 10,000 in savings bank account for a financial year is tax free.
Corporate/ NBFC Deposits – I keep writing about fixed deposit schemes from corporate and NBFCs. These generally offer higher interest rates than bank FDs and hence make sense to invest with them. But you must understand that the higher return is due to higher risk that you take while investing in these deposits. You should only invest in reputed corporate, government backed companies or AA and better rated NBFCs, Corporate deposits.
PPF (Public Provident Fund) – Its offering 8.8% interest and the best part it gives 80C benefit of saving and tax and the interest earned on PPF is also tax free. So your return would stay above inflation most of the time.
EPF/VPF – EPF/VPF is offering 8.5% interest rates. This too like PPF is a tax saving instrument as per Sec 80C and the interest earned in not taxed.
Tax Free Bonds – These bonds are offering tax free interest rates of 7.38% to 7.69% (for retail investors) depending on tenure. If you compare these interest rates with the FD post tax returns in the table above, you would find it makes definite sense for people in 30% tax slab to invest in tax free bonds. Also there is opportunity for people in 20% tax bracket to invest in Tax Free Bonds if they cannot find FDs paying more than 9%. The good news as per Budget 2015 is there would be more offers for Tax free bonds in the next financial year too but the interest rates might come down. Click here to check Tax Free Bonds open for subscription.