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RBI repo rate cut: How you can maximise your FD returns

Aprajita Sharma     May 22, 2020

Fixed deposits are the preferred investment choice for most Indians. More so at a time when the country is fighting a pandemic and the stock market is on a volatile trajectory while debt mutual funds have garnered bad reputation due to corporate defaults and liquidity issues. If you are a risk averse investor looking to park your surplus cash in FDs, but disappointed with low interest rates that public sector banks are offering, you must know there are ways, if planned well, to earn decent returns on FDs. Let's see how:

1. Ladder your FDs

Since banks want you to stick to your FD tenure, many of them charge pre-withdrawal penalties. Besides, the highest rate on FDs are generally offered on long term tenure mostly above five years. However, if you book FDs for five years and interest rate goes up substantially after a year or so, you may lose this opportunity. Besides, booking your FD for 5 years will mean that you do not enjoy any mid-term liquidity.  If you need above average interest rate and liquidity at all times, the ladder approach is an interesting way to manage your FDs. For example, if you have Rs 5 lakh to invest in an FD, invest Rs 1 lakh in one-year FD, another Rs 1 lakh in two-year FD and the rest three blocks of Rs 1 lakh in the tenures of three, four and five-year FDs. After a year, your first FD will mature that you can reinvest for next five years and the very next year, your second FD will mature, which can be invested for another five years. This way not only your investments will remain liquid but also you can avoid interest rate risk. Since it's hard to predict interest rate cycle, there could be a possibility that all your FDs mature at a time when interest rates are lower. Laddering helps you average your FD investments across the interest rate cycle.

Also read: India's GDP growth in FY21 to remain negative, says RBI's Shaktikanta Das

2. Avoid long-term FDs

Currently, we are in low interest rate regime. The RBI has cut repo rate by another 40 basis points to its lowest ever at 4 per cent. Most experts believe there could be further rate cuts to support dwindling GDP growth due to coronavirus-led lockdown. That said, this is not the time to lock your money in FDs with longer tenures.

Since banks pay higher interest rates if you invest larger sums for a longer-term, make sure to invest the amount that you wouldn't need anytime soon to avoid paying pre-withdrawal penalty.  "A 5-year bank FD offers good rate of return and also qualifies for deduction under section 80 (C) of the Income Tax Act. Further, try and place a portion of your FD portfolio in banks where there is no penalty for premature encashment - just in case!!," says Raj Khosla, founder and managing director, MyMoneyMantra.

Also read: RBI Governor briefing highlights: Repo rate cut by 40 bps to 4%; loan moratorium extended by 3 more months

3. Don't liquidate existing FDs

If you are not doing well financially and need some cash, better to take loan against FDs instead of liquidating those prematurely because not only will you pay penalty but also you will forego high-interest earning FDs compared to what is available in the market now.

Also read: Big relief! RBI extends export credit period to 15 months from 1 year

4. Go for auto sweep option

Many banks offer you sweep-in facility under which any excess amount in your savings account as specified by you will get swept into a fixed deposit that you have with the bank and start earning higher interest rate. You can anytime withdraw this excess amount in your FD without any early withdrawal charges. However, please check the tenure of the auto sweep FD if it will give you the best interest rate or not.

Also read: India's GDP growth in FY21 to remain negative, says RBI's Shaktikanta Das

5. Diversify; don't stick to one bank

People tend to open FDs in a single bank where they have the savings account. However, you must diversify your FD investments in public, private, NBFCs and even small finance banks. "The rates of return offered by all mainstream banks presently vary from 3-6 per cent, while small banks and NBFCs are offering better yields at 7-8 per cent, annually. Choose a right mix for the best returns," says Khosla.

Also, avoid keeping more than Rs 5 lakh in one bank, especially when it is a small finance bank.  "In case you want to park more than Rs 5 Lakhs in Fixed Deposits, you can certainly consider holding high yielding deposit schemes with several small banks and ensure better cash flows, along with capital security," he adds. Further, he cautions that you should opt for banks with Crisil's FAAA/ FAA rating for long term deposits, and A1+ rating for short term deposit schemes.

Also read: Coronavirus impact: Inflation outlook uncertain at this point, says RBI's Shaktikanta Das

Giving a contrary view, Suresh Sadagopan who is the founder of Ladder7 Financial Advisories says one should go for perpetual bonds (also called AT1) with a PSU bank like SBI instead of FDs with small finance banks. "Perpetual bonds don't come with a guarantee, for sure, but the ones with SBI can be trusted. Since AT1 bond with SBI and an FD with a small finance bank will give you similar yield, why not choose a public sector bank product," says Sadagopan.

6. Invest in AAA-rated company FDs

If you can take some risk, you may consider investing in company fixed deposits, but make sure to choose the ones with AAA rating. "Private lenders are offering interest rates of 7.6 per cent (cumulative) on FDs for tenures of nine to 10 years and of course an additional 0.25 per cent interest rate to senior citizens. These are unsecured loans and investors need to carefully scrutinise the underlying assets to ensure investment in high-credit rated companies," says Tarun Birani, Founder & CEO, TBNG Capital Advisers.

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