Invest in FDs for risk-free returns

Being a person from the technical domain, I always viewed finance, investments, savings etc as an accountant's job.

But since the past few days (especially during last year when things have so dynamically changed in the stock markets) I have realised how important it is to keep a tab on current happenings and channelise our savings and investments in a suitable way for getting optimum returns.

I am talking about the volatile stock markets and higher risks associated with investing in equities and the simultaneous but a steady increase in fixed deposit (FD) rates offered by the banks to their customers.

As banks are finding it tough to borrow from the central bank, the Reserve Bank of India, RBI, and other banks due to a host of reasons, they have turned their focus on your money. Normally banks borrow money from other banks and from the RBI to meet their demand for funds.

You and I have become important once again in the banks' scheme of things. We, too, are moving towards bank FDs because they offer 8.25-9 per cent returns per annum (these rates vary from one bank to another and you need to be judicious in picking where to put your money) for a five-year deposit with them.

• Dos and don'ts for stock market investments 

What's more, if withdrawn after five years, the interest earned on such FDs is absolutely tax-free.

From a lowly 5-6 per cent return on a five year FD, banks are now offering anywhere between 8-9 per cent returns on a FD of similar tenure. For senior citizens, these rates are higher at 9.5-10 per cent.

What's more you are sure that your principal amount will earn you some interest and this contrasts well with investments in the stock market.

But then, there are some investors who'd want a higher rate of return on their capital (the principal amount in five years) then say what the pure FDs offer.

Before we move on to that part of the story, let's see, how much can one earn by investing Rs 10,000 for five years in a bank FD that offers 9 per cent per annum.

Here is a simple back-of-the-envelope calculation:

• Rs 10,000 @ 9 per cent = Rs 10,900 – End of 1st Year (10,000 as principal amount plus interest @ 9 per cent)
• Rs 10,900 @ 9 per cent = Rs 11,881 – End of 2nd year (10,900 as principal amount plus interest @ 9 per cent)
• Rs 11,881 @ 9 per cent = Rs 12,950 – End of 3rd year (11,881 as principal amount plus interest @ 9 per cent)
• Rs 12,950 @ 9 per cent = Rs 14,116 – End of 4th year (12,950 as principal amount plus interest @ 9 per cent)
• Rs 14,116 @ 9 per cent = Rs 15,386 – Amount at maturity + Rs 3,000 IT rebate under Section 80C

If a similar amount is invested in National Savings Certificates, NSCs, then it will take approximately a year more to earn the same amount (NSCs have a fix tenure of six years) as above plus the added disadvantage of not getting accumulated interest if you were to break your NSC within the first 2 years, which is not the case with bank FDs.

• PPF vs NSC: What's the difference?

Now let us get back to how you can invest your capital in a blend of tax-saving and return-enhancing style to get the optimum returns without the worry of stock market volatility.

Club your savings in these FDs with Systematic Investment Plan, SIP, of an MF (say HDFC Equity diversified equity scheme as a conservative option for MF investment) and I bet you would not only beat the inflation rate easily but also have good surplus 5 years down the line with reasonably greater degree of safety.

I will try to get my point across with one example.

An investor, say Raghav, bought 1000 units of a diversified equity fund for Rs 10 in March 2006 when the units were offered directly by this mutual fund for the first time (New Fund Offer or NFO) to investors.

Within one year, Raghav's unit gained 25 per cent. This was a lump sum investment with all investment (Rs 10,000) done during the NFO period.

• How equity funds help you make money

However, if he had followed a systematic investment plan (SIP – instead of lump sum investment one can put in a small amount every month) approach his investment would have gained by almost 45-50 per cent.

The reason was the big market crash in May-June 2006. During this period the Bombay Stock Exchange's benchmark index, Sensex, slumped to 9,000 and his unit's net asset value, NAV, fell to Rs 7.7. Of course, the unit value gained again as the stock markets picked up later.

However, instead of lump sum investment if had a SIP in place he could have used this market fall to his advantage. He couldn't because all his "cash-to-be-invested" was already done with (assuming he had only Rs 10,000 as the cash-to-be-invested) during the NFO.

The equity markets will show volatility over a period of time and its up to the investor to maintain his/her balance as per his/her appetite and individual requirements.

With the level of optimism surrounding the Indian economy in times to come, I am reasonably sure this strategy will give us handsome returns combined with assured capital protection, notwithstanding the fact that nobody can predict the future.

This may not be the case if one were to invest all his money in the stock markets. Here it will be apt to quote the old adage: Never put all your eggs in one basket.

While potential returns from investing in stocks will be much higher they come associated with higher risk of a sharp stock market fall and in some cases erosion of your principal amount by more than half.

• How is bonus taxed?

I almost wonder on the dynamic way things change around us and how it forces us to re-think about the way we plan for our future.

Going back to the end of 2nd paragraph of this article, I repeat that the best strategy is to keep building savings (monthly, quarterly or half yearly depending on your convenience) and then channelise these savings in different avenues according to "the trend of the times".

We must learn the fact that everything is a part of economic cycle (what goes up must come down and vice-versa) and we must decide what suits our objectives in a given time frame.

The best way to keep this in mind is by remembering the phrase (I read this phrase on www.rediff.com sometime back): "Our investment should be treated like a chapatti and we must know when and how to turn and shuffle it around without burning it..."