In times of inflation, make a beeline for fixed deposits
Spiralling inflation, rising interest rates, a flat stock market and falling bond prices – this has largely been the scenario in the country over the past six months or so. The Reserve Bank of India (RBI) has been in-creasing the key interest rates gradually quarter after quarter and it appears that some more hikes cannot be ruled out. Crude oil prices have gone up substantially over the past few months. They are likely to remain high because of political uncertainties in the Middle East as well a possible shift from nuclear sources to oil and gas by Japan that is trying to rebuild the nation from the humongous natural calamity that it faced recently. High interest rate is definitely bad news for corporate bottom lines.
The stock market is trying to price in the fact that corporate earnings growth can be severely hampered by rising interest rates. The one silver lining in a marketplace where prices have been rising is the higher interest rates that savers will get on their investments in fixed-income securities, especially bank fixed deposits. Many banks are offering two-digits returns even on long-term fixed deposits. Bonds like State Bank of India, which came to the market in February 2011, offered 9.95% p.a. coupon rate on long-term bonds.
Banks have started increasing the interest rates on deposits and advances. Of late, interest rates on deposits have tended to move up ahead of RBI’s policy rate announcements. There is a general consensus among bankers and economists that inflation rate may come down due to the base effect as well as steady commodity prices and that the interest rate rising cycle may be nearing its end. While further interest rate hikes are not ruled out, the current interest rates are quite attractive.
At this juncture, all classes of investors can consider allocating more money to fixed-income options like bank fixed deposit because the stock market is not exactly cheap at the current levels and that the short-term outlook appears negative. Younger investors can continue their long-term investments in diversified equity mutual funds through SIP because the long-term outlook for the Indian economy continues to be good. Those who will retire shortly or are already retired can now take a close look at bank fixed deposits as well as corporate bonds/debentures for their fixed-income requirement.
Investors whose incomes are below the basic exemption limits in the Income Tax Act or those whose taxable incomes are below Rs 5 lakh and, are hence are paying tax at 10% or less, will be better off investing a bigger portion of their corpus in bank fixed deposits and/or corporate bonds are offering returns in excess of 10% p.a. This class of investors can consider withdrawing the maximum possible amounts from their PPF (Public Provident Fund) accounts and investing in bank fixed deposits. Even if they paid 10% income tax on their interest income, they would still end up with 9% p.a. net of income tax, which is fairly decent at a time when the equities are not offering any positive return at all.
Investors should prefer long-term fixed deposits at times when the interest rates are high. The best of bank deposit options that readily comes to mind is the fixed deposit scheme of Canara Bank which currently offers 10.50% p.a. to senior citizens on terms ranging from 8 years to 10 years – the rate is higher compared to many other banks and the term is longer. High net worth individuals who are required to pay tax at 30% can consider fixed maturity plans (FMPs) of one-to-three -year terms. Most of the FMPs invest in bank CDs and the current return on these is around 10%. Post expenses, investors can expect yields of around 9.50% p.a. or more. This is a very tax-efficient option.
The returns, post tax, for HNIs can work out to around 9% p.a. in the current market scenario. Commodity prices are also likely to remain high in view of global demand political uncertainties and huge rebuilding in Japan. Gold, in such uncertain conditions, offers an excellent hedge as well as diversification for one’s portfolio. The yellow metal can now be easily added to the extent of around 5-10 % of one’s portfolio through systematic investments offered by Reliance Gold Savings Fund and Kotak Gold Savings Fund where one can invest in Gold Exchange Traded Fund, without having to open demat and share trading accounts.
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