Wise Wealth Advisors

D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Risk with your Fixed Deposits

Posted by Muthu on December 6, 2014

RBI policy review on December 2’nd made it abundantly clear that we would be entering the softening of interest rate phase from early next year. It also mentioned that future policy reviews would be consistent with the same (i.e.) we are entering a lower interest rate regime.

RBI also aims for a long term inflation rate of 4% with real interest rate being around 1.5%. This implies over the medium term of next 3 years or so, the deposit rates may even settle around 5.5% to 6%.

In the last few days, SBI, HDFC Bank, ICICI Bank etc. have started cutting deposit rates. HDFC Bank has mentioned yesterday that even lending rates would start coming down from March.

In Nineties, due to high inflation, a fixed deposit rate of around 12% was normal. Even provident funds used to give such rates. I remember my father getting around 15% from his Sundaram Finance deposits.

During last one decade, 8% became the new normal. Twelve and fifteen percent became a history of the past. As the country grows, focus of both RBI and government is on lower inflation and interest rates. The new normal for interest rate in this decade may become 6% over the course of next couple of years. Eight percent may become a history.

If you rely on fixed deposits for your sustenance, a fall from around 9% interest rate to 6% interest rate would mean that loss of one third of your income in next couple of years. The most difficult situation in your financial life can be when expense keeps increasing and your income keeps falling.

We’ve been advocating keeping only emergency fund in fixed deposits and invest the rest in MIPs (Monthly Income Plans) and generate a fixed income through SWP (Systematic Withdrawal Plan) option.

Based on the long term track record, MIPs are capable of giving around 2% better than fixed deposits. During interest rate falling scenario, like the one we are having now, MIPs deliver excellent returns.

During last one year, the G-Sec yield has dropped around 100 bps (basis points) or 1%. As you are aware, when interest rate falls bonds rally. Equity market also did well. So the last one year return of many good MIPs is around 20%. Yes you read it right, it is 20%. Due to expected fall in rates, for next 3 years, we expect MIPs to provide returns in mid to higher teens. There is no guarantee. This is based on our reading of the situation.

On one hand you are going to get lesser rate of return in fixed deposits when you go for renewal in future. On the other hand, MIPs are going to give you higher benefits due to the same falling interest rate. Not only that as equity market is also expected to do well, it would be icing on the cake in providing better returns. So which one you should choose? FD or MIP?

So my suggestion for you is to keep only any contingency fund in fixed deposits. The rest may be invested in MIPs. Please note that when you invest in MIPs, you should keep in mind an investment tenure of not less than 5 years. Or in a favourable scenario like this, at least 3 years. Anything less than 3 years, it is better to continue with fixed deposits itself.

2 Responses to “Risk with your Fixed Deposits”

  1. Akhilesh Gururani said

    Querie 1. You write and I quote ,”So my suggestion for you is to keep only any contingency fund in fixed deposits. The rest may be invested in MIPs. Please note that when you invest in MIPs, you should keep in mind an investment tenure of not less than 5 years.” unquote.

    Sir, Your statement confuse me. Please clarify, how would someone manage by investing everything else in MIP? And what do you mean by Contingency fund? Example of my confusion is – If my horizon in MIP is at least 3 years then how do I manage cash flows in case I need something after two years?

    Querie 2. You write and I quote, “We’ve been advocating keeping only emergency fund in fixed deposits and invest the rest in MIPs (Monthly Income Plans) and generate a fixed income through SWP (Systematic Withdrawal Plan) option.” unquote.

    Sir, Given the tax implication of debt funds ( I assume MIP is one), are you suggesting that I wait three years before I start the systematic withdrawal plan and hence wait for three years for the fixed income to start? How do I manage fixed income in the intermittent periods?

    • Muthu said

      1) Contingency fund also refers to emergency fund wherein one keeps at least 6 months to 1 year of expenses in FD as a backup for any emergency. You only need to keep in MIPs that fund you don’t require for at least 3 years.

      2) We generally suggest withdrawal from 13th month as some accrual / gain would have accumulated by then. For the first 2 years of withdrawal, taxation would be in the tax bracket investor belongs to. From 37th month, taxation at 20% with indexation, the tax outflow would be negligible.

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