Why this is not the time to take on very long-term fixed deposit investment

For periods longer than 3 years, it is a good idea to explore debt mutual funds that offer indexation benefits and lower the tax outgo

Banks have raised their fixed deposit (FD) interest rates following the central bank's 190 basis point increase in the repo rate since May.

Retail inflation in the country was at a five-month high at 7.4 per cent in September. "This, along with the aggressive monetary policy action by the major central banks and pressure on the rupee, should lead the Monetary Policy Committee (MPC) to opt for further repo rate hikes, which in turn should lead the banks to steadily increase their FD rates," says Gaurav Aggarwal, senior director, Paisabazaar.

What's happening

Banks increased deposit rates to meet growing credit demand as liquidity tightens, but their move has not kept pace with Reserve Bank of India’s rate hikes. "We have some way to go in terms of reaching the terminal rate where there will be a pause," says Tarun Birani, founder and chief executive officer (CEO) of TBNG Capital Advisors.

"Interest rates on FDs have largely lagged the pace of rate hikes as the RBI undertook a 190 basis point hike in policy rates since May this year. For instance, most major banks are currently offering around 5.7 per cent on 1-year FDs while a 364-day T-bill is trading at 7.02 per cent," says Praneet Battina, investment team, Fi Money.

Banks try to earn their profits by maintaining and increasing NIMs (Net Interest Margins) through increasing loan books as well as increasing Net Interest Income (NII). "Hence, increasing credit demand will definitely lead to economies of scale due to increasing loan books. Even though loan rates will increase due to increasing cost of money for banks, the competitive landscape and individual growth targets will also impact the pace of rate hikes," Birani says.

Real rates on FDs haven't turned positive. "Real rates are still not positive, especially with September Consumer Price Index (CPI) data, FD rates are still in the negative zone. Net of taxes, the returns are even lower," says Renu Maheshwari, board member, Association of Registered Investment Advisors (ARIA).

What should investors do

Some banks offer attractive interest rates of over 7 per cent on FDs around the 700-750 day tenor. "For investors looking at FDs only, this may be a suitable duration to lock," Battina says.

When looking for a long-term investment, you should heed the advice of financial professionals, especially if you're considering locking in significant funds due to high-interest rates. "We do not recommend locking in the FDs for the long term as yet. Three-year term deposits are still in negative return territory," Maheshwari says.

Of course, there's no point in keeping money idle in a savings account. In volatile times, don't try to time the market too precisely with the rate movements. "If one wishes to still time to some extent, take a four-month auto-renewal bank FD and stop auto-renewal if suddenly rates go up substantially," says Sanjeev Govila, a SEBI-Registered Investment Advisor (RIA), and CEO, Hum Fauji Initiatives, a financial planning firm.

Alternately, Govila says that high-quality corporate FDs can be taken fully or partially with the investible amount kept aside for FDs. What about small finance banks (SFB) or cooperative banks?

SFB and medium-sized banks are offering higher rates compared to large ones. Cooperative banks could offer rates that are better than even the small finance banks. "A word of caution; do assess the bank’s reputation before committing funds," says Raj Khosla, founder and managing director (MD) of MyMoneyMantra.com.

Deposits in India are secured by insurance up to Rs 5 lakh. Khosla adds, "Therefore try and limit the deposit amount so that you are covered by the guaranty. While making a deposit, customers should also consider ease of booking and maintaining the deposit."

While some advisors suggest making the most of SFM with smaller amounts. Govila says, "SFBs a notch higher than other scheduled commercial banks on the risk scale. If one is comfortable with it, one may place a small component of the money allocated for bank FDs there."

Investors should check their existing fixed deposits and they can re-book them at higher interest rates. Khosla says, "Investors can also book their FDs at different maturity tenures as it provides liquidity to the investor and manages the re-investment risk. This technique is called "laddering."

Some experts suggest a park-and-wait-and-watch approach, as this is not the time to take on very long-term FDs since rates are likely to go up. Govila says, "Right now, invest in a 12-month FD. and when the rates stabilise, go in for a longer-term FD." Taking 12-15 months, high-quality corporate FDs with AAA ratings that still fetch good rates can be considered in this segment. But, if you are determined to invest substantial amounts in FDs right now, you should spread your investments across two-three FDs in multiples of ~5 lakh.

Apart from the interest rate, consider the credibility of the financial institution, compounding frequency, and total return.

The shorter the compounding period, the greater the return you will get on your investment.

Battina says, "Comparing FDs across different financial institutions on these points also factors in inflation and taxes to get a better idea of your real return." Premature withdrawal penalties are important to consider.

When investing for more than three years, experts suggest alternative investments.

Alternatives to FDs you may consider

Currently, investors can also earn good returns by investing in the bond market. The 1,500 crore National Highway Investment Trust (NHIT) non-convertible debentures (NCD), which are AAA-rated and will hit the market on Monday, is offering a coupon of 7.90 per cent semi-annually (which means investors will be paid 3.95 per cent at six-monthly intervals), which amounts to an annualised yield of 8.05 per cent. It has a tenor of 25 years. Another AAA bond that is available currently is from HDFC. This is a 10-year paper with a coupon of 8.07 per cent and a yield of 8.02 per cent.

Bonds having a rating of AA and AA+ from Shriram Transport, Piramal, and Shriram City Union are offering yields between 8.5 per cent and 10.5 per cent. "If you invest now with a three-to-five-year horizon, then there is a good chance that you could also earn capital gains," says Ankit Gupta, founder, BondsIndia.com.

Investors investing in bonds should not rely on ratings alone. Also study the financial position of the entity—its size, the business it is in, its level of debt, and so on to get a better picture. While ratings may be good when you invest, they can plunge by several notches suddenly if the fundamentals nosedive.

"In the mutual fund space, investors may look at banking and PSU debt funds, which are offering the yield to maturity (YTM) in the range of 6.4-7.5 per cent.

You can also look at longer-term target maturity funds maturing in 2027-2032, whose YTMs currently range from 7.14-7.66 per cent," says Arnav Pandya, founder, Moneyeduschool.