With the markets down, bank fixed deposits for terms less than five years with 9.6-10.3 per cent interest rate look attractive. But are they?
No, if your income is in the 20 or 30 per cent tax bracket. The 9-10 per cent rate advertised is only the pre-tax return. You need to look at the post-tax return and this is where FDs lose out, especially for those in the highest 30 per cent tax bracket.
Interest income from FDs are taxed at the marginal rate, with no exemptions or deductions available unless it is a notified five-year FD. So, for someone in the 30 per cent tax bracket, the 10 per cent return from an FD becomes 7 per cent.
Inflation. Touching 12 per cent now, inflation plays a role too. So if you invest your money in an FD, your real return would actually be negative.
A better deal. If your aim is a debt option, fixed maturity plans of mutual funds with tenures of 30 days to three years are a better bet. FMPs are closed-end debt funds that invest only in debt paper of exact or comparable maturity, because of which they effectively lock into the prevailing yield.
FMPs with terms more than one year provide capital gain efficiently by structuring it in a way so as to give you double indexation benefits. For example, if you hold an FMP that was launched on 30 March 2008 with a tenure of 370 days, and you hold it till maturity, you can use the cost of inflation index applicable for the year of purchase as well as for the following year, the year of redemption. Expense ratio (the expenses incurred by the fund to manage investments) for FMPs is 0.25-1 per cent.
Also, FMPs have a tax advantage over FDs because the interest from FDs can be taxed at the highest rate. FMPs attract dividend distribution tax of 14.1625 per cent but the maturity amount is tax-free. However, you also need to evaluate the credit risk involved in the underlying securities held by the plan.
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1st person: 10% returns from a fixed deposit sounds good. 2nd person: Not really, because after inflation and taxes the real returns can actually be negative. |
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