With the Reserve Bank of India (RBI) hiking repo rates over the last few months, some banks have hiked their fixed deposit (FD) rates and others are expected to follow suit. However, the returns from FDs are still below inflation, and small savings schemes such as Public Provident Fund (PPF) may be better options for investors.
In the monetary policy announcement on Friday, RBI again hiked policy rates by 0.5 per cent, taking it to 5.4 per cent. Since April this year, the RBI has raised the repo rate by 140 basis points (bps). One bps equals 0.01 percentage point.
At present, the rate of interest on FDs for general citizens are in the range of 5-6 per cent per annum. Some banks are also offering three-year FDs with rates of interest of up to 6.5 per cent. On the other hand, senior citizens are able to get 6-7 per cent per annum on their deposits. For instance, the State Bank of India is offering a return of 2.9-5.5 per cent per annum on deposits, while HDFC Bank is offering a rate of interest of 5.75 per cent per annum for deposits with tenures between five and 10 years.
So, should you invest in FDs now given the rising deposit rates?
Though FD rates have gone up from the all-time lows before April, the real returns from FDs are quite low. “Usually, people ‘invest’ in FDs with the mindset of getting guaranteed return. But people do not realise the utility of the after-tax ‘guaranteed return’ which fails to beat inflation,” says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.
If an FD is offering a certain percentage of return, it is not the actual rate of return one is earning. This is because inflation and taxes take a chunk off from the returns.
Here’s how it works out: If one spends Rs 100 today, next year, he/she will need Rs 107 (because of inflation @7 per cent). If one invests Rs 100 in FDs and gets 6 per cent per annum, the tax bite will reduce it to 4.2 per cent, assuming he/she is in the 20 per cent tax bracket. The payout after a year will reduce to Rs 104.2 after one year, though the investor needs Rs 107.
If the money is needed for specific purposes, the inflation will make the shortfall even higher. “If one considers education and medical inflation, whose figures are in double digits, the situation would become even more critical,” adds Sen.
Small savings schemes are better than FDs as they not only provide returns that are generally higher than bank FDs, but also come with a sovereign guarantee and tax benefits.
For instance, investments in Public Provident Fund (PPF) offer a tax-free return of 7.1 per cent. PPF investments are also deductible under Section 80C of the Income Tax Act, 1961. Tax-saving five-year FDs are also tax deductible under Section 80C.
That said, PPF has a lock-in period of 15 years.
One could also consider investments in National Savings Certificate (NSC), which offers a return of 6.8 per cent but has a term of five or 10 years. That said, they have one drawback. While one can claim deduction under Section 80C for investments in NSC, the interest is taxable in the fifth year.
FDs maybe a good investment option when the investment horizon is less than three years, as for short periods, you would need to park money in safer instruments. Equity markets are volatile in the short term, while small savings schemes have a higher lock-in period.
However, FDs may not be able to provide for long-term goals, such as child’s education, retirement, due to the low returns, especially if inflation is high.
