The Most Authentic Guide on Personal Finance and Investments


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Fixed Deposit Or Debt Fund Or PF Or Tax-free Bond Or...

There are many types of fixed-income investments. These mainly include
- Bank Fixed Deposits
- Company Fixed Deposits
- Company Bonds and Debentures
- Tax-free Bonds
- Govt. of India Savings (Taxable) Bonds
- Debt Mutual Funds
- Employee Provident Fund (EPF)
- Insurance policies such as moneyback and endowment
- Post Office Small Savings Schemes (e.g. PPF, POMIS, Senior Citizens Savings Scheme, Sukanya Samriddhi, Kisan Vikas Patra and many more)

Given this wide variety of schemes — each with its unique pros and cons — you need to choose your investment option(s) rather carefully. Otherwise, you may end up with a product that does not meet your requirements... and consequently suffer not only inconvenience but also losses.

Listed below are 35 salient aspects of these fixed-income investment products.

1. Bank fixed deposits are a simple and safe investment (unless you make deposits in some co-operative banks with dubious credentials).

2. Rate of interest offered by banks is likely to be 1-2% lower as compared to some other options.

3. Premature withdrawal of bank FDs is easy. But you will get lower than the contracted interest rate. Plus, there may be a penalty too.

4. The interest earned on fixed deposits is fully taxable (except for the Senior Citizens, who have been granted an exemption up to Rs.50,000 w.e.f. FY 2018-19).

5. Tax on interest income is payable every year on accrual basis. So for a cumulative multi-year deposit you have to annually pay tax, even though you don’t receive any interest in hand.

6. Interest income is also liable for Tax Deduction at Source. So, banks will deduct TDS on your interest earnings as per the rules prescribed.

7. Company fixed deposits offer higher interest rates, but aren’t safe and simple. There is high risk of default and premature withdrawal is not easy.

8. Like bank FDs, the interest income on company FDs is fully taxable on accrual basis and TDS is applicable.

9. As compared to company FDs, the listed company bonds and debentures may offer better liquidity, PROVIDED the trading volumes are good.

10. Another advantage of listed company bonds and debentures is that after one year the capital gains are treated as Long Term Capital Gains and taxed at 10%.

11. There is NO TDS on the listed company bonds and debentures held in the demat mode.

12. The risk on company deposits and bonds can be reduced by investing only in AAA-rated companies with excellent fundamentals.

13. Holding a diversified portfolio of deposits and bonds can also mitigate the risk. In fact, debt mutual funds automatically give you a diversified portfolio even with one scheme.

14. Interest income from listed tax-free bonds is exempt from tax. But, capital gains if any, are taxable.

15. Listed tax free bonds have been issued by public sector companies and hence the risk of default is minimal.

16. However, the yields on tax-free bonds are presently not very attractive.

17. You should have a demat account if you want to invest in listed bonds. For such accounts you have to pay annual charges.

fixed-income-investments
Focus on the salient features of various fixed income investments.

18. Post Office Small Savings Schemes offer safe and good returns that are comparable to the prevailing market rates.

19. Interest income from all PO Small Savings Schemes is taxable…except PPF and Sukanya Samriddhi Scheme (but they don’t offer easy liquidity).

20. Likewise, EPF too is a 100% safe investment and offers high tax-free returns. But it again is a highly illiquid investment.

21. Senior Citizens Savings Scheme and Pradhan Mantri Vaya Vandana Yojana are good schemes for those 60 and above.

22. Persons below 60 can consider the 7.75% Govt. of India Savings (Taxable) Bonds.

23. Returns on the traditional insurance plans such as moneyback and endowment are tax free. But the yields are very (very) low, in the range of around 4-7%.

24. Plus, the insurance policies rate very low on liquidity. You have to pay exorbitant costs if you surrender your policy before maturity. 

25. Debt mutual funds offer a diversified portfolio of company bonds, Govt. securities and bank deposits. Hence, the risk in such schemes is quite low.

26. The only risk that can significantly impact the debt funds is the interest rate risk. This can be reduced by investing in short term debt funds or Fixed Maturity Plans (FMPs) or holding for extended period across 1-2 interest rate cycles.

27. Long term debt funds offer excellent opportunity to earn huge capital gains — in addition to the interest income  PROVIDED you can correctly time your investment and exit.

28. Debt funds (except FMPs) also enjoy excellent liquidity, unlike all other fixed-income investments, which often have long lock-in periods.

29. Subject to interest rate risk (which anyway is notional until you actually redeem your investment), debt funds have the potential to yield 1-2% higher returns than bank FDs.

See The Curious Case Of Poor Returns From Debt Mutual Funds.

30. The biggest advantage of debt mutual funds, especially for investors in higher tax slabs, is much lower tax liability. When the holding period exceeds 3 years, the gains are taxed as Long Term Capital Gains @20% with indexation benefit. Depending on inflation the effective tax payable normally works to 10% or even lesser.

See 57% Tax Cut On Debt Mutual Funds Vs Fixed Deposits.

31. In debt funds, avoid the ‘Dividend’ option. ‘Growth’ option is a better alternative… because tax on dividends is much higher as compared to the tax on capital gains.

32. The tax on capital gains is payable only at the time of redemption, and not on accrual basis like the FDs. Tax on dividends is deducted at the time of dividend distribution.

33. Compared to penalty on premature withdrawal in FDs, there is no penalty — known as Exit Load in mutual fund parlance — after a specified holding period (ranging from 0 to 365 days depending on the type of scheme).

34. Also, unlike lower rate applicable on premature withdrawal in FDs, you always get the market NAV on redemption. Hence, there is no loss on early encashment.

35. Another great feature of debt funds is NO TDS.

This, in brief, are the salient features of various fixed income investments. For maximum gains with minimum fuss, you need to create a portfolio that correctly matches your requirements.

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