Carefully Calculating Returns

Are you a laid-back investor - content with the five per cent interest you accrue on your savings account? Maybe you rouse yourself from your state of inertia once in a while to make an FD in your bank - the childs education, marriage or purchase of property may have prompted this sudden activity. How much do you earn? Definitely, not more than the stipulated 15 per cent and that too on tenures beyond five years. But, it is the safest venture, you may well argue, especially as banks are flush wiith funds these days.

True, and this together with a better network has helped banks especially public sector banks in handling nearly 90 per cent of business in deposits. However, with the equity market still floundering on a bearish note and the freeing of interest rates for the top bracket NBFCs, a lot of risk takers have started eyeing this avenue especially the company deposits offered by finance companies.

After all, the golden rule Higher Risk Begets Higher Returns is equally evident here as well. For an average investor, however, it is always better to spread ones investibles between high and low risk companies. Even so, at the same time one can cast an eye around and pick up schemes that ensure higher yields.

While judging a company and its scheme, it is important to look for indicators like the rating of the company - which may not be an absolute indicator but nevertheless gives an idea about the companys current standing in the market.

Equally important, is the liquidity of the company lack of liquidity in even a high rated company may result in delayed repayments especially if you do not intend to renew or roll over your deposit. You can also examine the profitability record and the size and age of the company that may indicate the companys progress.

Another indicator could be the type of business conducted by the company. For instance, a company that lends money in a sector like auto financing has better possibility of returns coming in regularly albeit one that blocks the money in risky ventures. With manufacturing companies, one can see the product and its popularity in the market to get an idea.

However, your yields or returns from a deposit depend on various factors like tenure, kind of scheme you opt for and the manner in which interest is calculated. The idea of wading through the plethora of schemes floated by all the companies around is an unfeasible exercise.

A good way to start is by comparing the top rated companies. The FD market indicates that triple A rated companies (highest safety) usually offer lower rates of interest than the double or single rated ones, that too are indicated as safe but are comparatively riskier. Thus, 20th Century Finance (FAAA, Crisil) offers 15 per cent on a one year regular income deposit while SRF Finance (FAA+, Crisil) gives 16.75 per cent on monthly and 17.25 per cent on quarterly income schemes for a year. (See Table).

The reason being that a lower rated company is usually in greater need of deposits as people naturally gravitate towards their more reputed rivals. If one is not averse to a bit of risk and has, say, a lakh to invest shuffling it partially between top rated and slightly lower rated companies will definitely reap bigger returns.

A lot of big companies collect deposits through a number of subsidiary companies. If the parent company has a high rating and some of the subsidiaries are good but of a grade lower rating, it may be possible to take a risk and deposit money in the lower rated but higher yielding subsidiary. The guiding factor being the hope that the parent company would bail the smaller one out in case of the company floundering.

The second factor would be the type of scheme. In regular income schemes, the interest is returned on a monthly, quarterly, half-yearly or annual basis with no interest being accrued on the interest component.

Lets take a look at the annualised yields. Assume you invest in a monthly income, a quarterly income and a cumulative scheme from Escorts Finance with interest compounded annually at 18 per cent. The annualised yields (see formula in table) will be 19.56, 19.25 and 18 per cent respectively. This indicates that returns would be highest in a monthly income plan effectively.

But the point to note is that this return is obtained on a tenure of 60 months for monthly income, 48 months for quarterly income and 12 months and one day in cumulative scheme. However, cumulative schemes are usually compounded on a monthly or quarterly basis and since the interest earned every month or every quarter also attracts additional interest, it goes without saying that the returns would be the highest in these cumulative schemes. With increasing tenure, the rate of interest also increases and so does the annual yield.

Moreover, a monthly income scheme usually charges a higher amount as the minimum deposit since the idea is to have a substantial income every month. However, this increases the tax deducted for a tax paying investor.

Similarly, the highest yields are obtained from the double your money schemes but here too the interest crosses the Rs 2,500 mark as the minimum deposit is quite high. So, if you dont mind paying some portion to the IT department, you could get better yields from such schemes.

Apart from this the hidden incentives that range from 0.5 to 4 per cent usually stretch your overall yields. However, these being offered by brokers and companies directly, the determining factor would be the amount of moolah you put in.