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Are you still investing in Bank FDs?

Suresh Sadagopan Published on Sep 10, 2008 So, you are still investing in FDs, eh?! Such benevolence! Selflessly thinking about the banks interest, by sacrificing your interest ( pun intended!). What altruism! Let me come to the brasstacks. Bank FDs are beneficial to banks not you. Let us see why. The tax treatment in case of FDs is detrimental to your interests for income from FDs is to be added back to your income and tax needs to be paid on it. Hence, what seems like the earning is not the actual earning. Lets take an example. Let us say a bank FD gives 10% interest for 1 year. Since the income is taxed and if a person is in the 30% bracket ( most of us are there or in the even higher at 33.99% ), the return is only 7%. When you look at this rate, it is not that interesting any longer, is it? Many tell me that bank deducts only 10%+ as TDS. Thats true. But the point is, you will need to pay the balance 20% tax yourself. Enter FMPs. Fixed Maturity Plans ( FMPs) are debt products from Mutual Fund houses, where the net return can be far higher, than in an FD. Better after-tax returns : The gross returns are 10.5%-11%. The tax treatment is favourable. If you are in the Dividend mode, the company pays tax of 14.16% on the returns and pays the balance, which is then tax-free in your hands. The returns will hence be greater than 9%, post tax. For FMPs of 12 months or above, longterm capital gains apply. Again it is to your advantage. One could pay 10% with indexation or 20% without and end up with much better post tax returns. Tenure to suit your need : Tenures are available from 1 month, three months, 6 months, 1 year, 2 years, 3 years & 5 years. There are also tenures like 371 days, 19 months, 15 months etc. So, one can invest in these till you may require the money and get good returns. Liquidity : Possible with appropriate exit loads. Ideally, one should invest only when one wants to hold to maturity; else, liquid plus funds are a better option. So, what in the world is this FMP? An FMP is also a 100% debt investment option like FDs. Here the investments are in Commercial paper, Certificate of deposit, Treasury bills, Debentures, Pass through Certificates etc. However, FMPs do not guarantee returns and give an indicative return, instead. But, that is more or less what one gets, as the investments are made in the underlying securites and typically held to maturity. Typically, good FMPs invest in good quality papers AAA, AA+, P1 rated ones. There is an element of risk of some underlying investment not paying on time or failing to pay, which is similar to risk of a company FD. But that is why, they go in for high quality rated paper to ensure that they can give the returns indicated. Who is this meant for? FMPs are meant for those who want to invest in debt instruments like FDs. Could be a great idea to invest in them as the differential return is quite pronounced. FMPs give 9% plus post tax. FDs could give about 7% post tax. NSCs could give 5.6% post tax. Even PPF gives 8% post tax. But apart from FDs, the other two are rigid and not really liquid. Make up your mind now. Do you want to help the bank to count their blessings, one by one FD by FD? Or you want to count yours? The choice is yours. Suresh Sadagopan is a Certified Financial Analyst. He can be reached at ladder7@gmail.com

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10/24/2008