With interest rates heading lower it is the right time to invest in fixed deposits

FDs: Time to take a call before next RBI Policy

If you are considering going the FD way, now is the time to make that move considering interest rates are heading down

 Jinsy Mathew   
  • September 14, 2015  
  • |  
  • UPDATED   15:41 IST

One of the best instruments for a conservative/low risk appetite investor is the traditional bank Fixed Deposit (FD  as these investments assure fixed returns. The other option that one has is opting for a debt fund which is offered by all the mutual funds houses. These debt funds claim to offer better returns as compared to an FD. However, the recent cap on redemption limit by JP Morgan Asset Management Company on two of its fund reveals the underlying risks debt funds are subject to.

In such a scenario, bank FD comes across as the safest option as the return from this instrument is fixed and secure with the principal amount protected. Other than this, the return generated will also be higher as compared to leaving cash in a savings bank account. Therefore, it figures as a favorite investment option among the senior citizens.

So if you are considering going the FD way, now is the time to make that move and that too before September 29, which is barely a fortnight away. The reason for this urgency is that the Reserve Bank of India is scheduled to come up with its bi-monthly Policy review on 29th this month, during which a 25 bps cut in repo rates is expected to be announced. Repo is the rate at which the Reserve Bank of India lends money to the banks.

Thus far in 2015, RBI has cut rates three times across January, March and June as a move to support the economy. Following suit, most of the major banking players have reduced their interest rates on fixed deposits. SBI, ICICI Bank, HDFC Bank, Axis Bank, Oriental Bank of Commerce and Punjab National Bank has all reduced their rates by a maximum of 100 bps or 1%, thus far.

If this expected rate cut were to become a reality, it will most likely translate into banks cutting FD rates further lower. Therefore, financial planners are quick to note that any fresh money should be locked in for longer duration rather than a typical one to two year time frame. Anil Rego, CEO of Right Horizons, a wealth management firm is of the view that given the direction of interest rate trajectory which is heading lower, it would be prudent for lower tax bracket people to lock in some of their free cash in longer tenure deposits at current rates.

Importance of tenure

One of the important factors while considering a move towards FD is the tenure for which the funds should be locked in. Given that interest rates are expected to edge lower it would be smart move to lock in free cash for a longer tenure sat three to five years, such that investors can continue to enjoy the current rate of interest even if the rates were to downhill in the days ahead.

The drawback of a one year FD currently is that when it is time to reinvest the amount, post maturity, the interest rate will be most probably lower that what it is today.

Interest Rate offered

The rates offered by banks whether a private or public bank varies from bank to bank. Interest rates are set on the basis of requirement of funds and the liquidity available with a bank. Hence, it would be advisable to do some basic research in the form of comparing the interest rates provided by various bank for a particular tenure before zeroing in a bank to put your hard earned money in.

Impact of deposit rate on returns

Currently, State Bank of India is offering a five year FD at 7.25%.As on date, an investment of 5 lakhs in a five year FD will fetch Rs 7.16 lakh, on maturity. If the banks were to lower rate by 25bps or 0.25%, the effective interest rate drops to 7%. In such a case, the returns would drop to 7.07 lakhs, which is a decline of Rs 9,000. If the downward revision turns out to be sharper at 50bps or 0.5%, the net return after five years would drop to Rs 6.99 lakhs, which is a difference of Rs 17,500. In the light of these numbers, a lock in at current rates is much more favorable.

Meanwhile, it should be noted that private banks like ICICI Bank and HDFC Bank offer deposit rates are a tad higher rate at 7.50% and 7.65% respectively.

Finally, keeping in view the macro trends, it will be an ideal time for those wanting to park money in FDs to opt for a lock in period of three to five years, especially for the ones who are in 10% tax bracket.