Can I invest in instruments other than FDs?

Bank Fixed Deposits are popular with traditional investors. They are considered safe and secure. It is good to park some money in FDs. But fixed deposits have some disadvantages too -

Interest received is subject to tax as per the tax slab you fall under.

FDs are illiquid and withdrawal before the due date attracts a penalty.

Interest rates are falling. Therefore post tax returns of FDs cannot beat inflation.

There are alternatives to FDs that have similar safety and security standards. Let us look at some of these investments -

1) Public Provident Fund (PPF)

PPF gives an interest rate 7.8%. Though the interest rate has been falling, it is a good investment option as investment in PPF can be considered as deduction for income tax calculation. The interest rate is still higher than FDs. Its duration is 15 years and can be extended which means it is a good option for long term investment and retirement planning. There are some allowances for withdrawal of money, loan against investment and emergency situations. Interest earned is also tax free. It is a low risk investment option.

Comparison to Fixed Deposits

As compared to FDs, the interest rate is higher and returns are tax-free. The amount required to open a PPF account is only Rs.100. The yearly deposit should at least Rs.500. FDs require a larger sum.

2) Debt Mutual Funds

Debt mutual funds are mutual funds that invest in debt instruments like debentures, bonds and government securities. They usually give a higher return than FDs. They are less risky as compared to equity MFs or balanced MFs.

Currently interest rates are falling which means prices of bonds are rising. Debt fund investors can get capital appreciation in this scenario. Long term gains in Debt funds are taxed at 20% with indexation and short term gains are taxed as per the person's tax slab. Dividend earned is tax-free.

Comparison to Fixed Deposits

Debt MFs are more risky than FDs. The returns are generally higher in debt funds as compared to MFs. Long term tax might be less for debt funds than FDs. Debt MFs are managed by professionals who try to optimize returns and dividend.

3) FMPs

FMPs are close–ended debt mutual fund schemes. They have a fixed maturity period. The corpus is invested in fixed income securities like Certificate of Deposits, Corporate Bonds, Fixed deposits, Money Market Instruments and Commercial Papers. Maturity period can be from one month to a few years. The long-term profits are taxed at 20% with indexation for FMPs that are growth based. Short-term profits are added to the income and taxed as per the tax slab that one falls under.

Comparison to Fixed Deposits

FMPs are transparent when it comes to investment portfolio whereas in FDs you are unaware of what is being done with your money. Risk is higher in FMPs than FDs.  Returns are not guaranteed in FMPs though Bank FDs are guaranteed by the government only to the extent of Rs.1,00,000.

4) Bonds

Bonds can be issued either by government, financial institutions or companies. They are issued to raise money. Investors buy bonds to earn interest on the bonds. There are tax-free bonds and tax saving bonds. Tax free bonds are bonds on which the interest is not taxed. Tax saving bonds are bonds that allow to save some tax liability.  Bonds can be traded on the exchange provided there are buyers and sellers. It is not always easy to find a buyer/seller and so liquidity can be an issue. Moreover one has to take care of the market rate of buying in the secondary market. Even if the interest rate is higher for the older bonds, if the market rate is more than the face value, the real yield will be lesser.

If one sells bonds in the market within one year, tax will be as per the tax slab that the person falls under. If the bond is sold after 1 year of purchase on stock exchange by paying due STT, tax will be 10% without indexation.

Comparison to Fixed Deposits

Bonds issued by the government are usually safe as they are backed by RBI. Other bonds carry more risk. One should buy bonds as per their credit rating. Bonds have the potential to earn interest as well as capital appreciation. Bonds are more liquid than FDs as they can be sold on the exchange unlike FDs. FDs can be withdrawn prematurely but at a cost. Interest earned on bonds is taxable unless it’s a tax free bond. Interest earned on FDs is taxable.

Inflation can play a spoilsport in your financial future. It is important to have a financial plan and an investment portfolio that will ensure that you earn enough to beat inflation and have long-term financial security.