Use tax efficient choices to counter falling interest rates
Fixed deposit interest rates in leading banks have fallen below the 7 per cent mark. This means that if one were in the highest tax bracket, the post tax returns would be below the 5 per cent mark. If you were a fixed deposit investor and your deposit is coming up for renewal, what are the options that one can pursue? The interest rate on small savings schemes has been further reduced for the July to September period. The first temptation is to invest into the equity market, despite the strong market performance increasing the risk for a new entrant. We discuss on the debt and hybrid alternatives, especially for investors concerned that the market has already gone up.
Look for tax efficient options
If you are a person in the higher tax brackets, you may be able to invest into options that deliver superior post tax returns compared to a fixed deposit. Even within the small saving investment options, one has options like PPF that deliver a good tax free return. It comes with much higher lock in periods though.
You could also use a debt mutual fund, especially if your investment horizon is above three years. Debt funds would be subject to preferential long-term capital gains treatment. In the current environment, you can choose between a fixed maturity plan, that comes closest to a fixed deposit; or look at short-term income funds. Corporate bond opportunity funds give you a higher yield, but do check out the credit rating of the underlying investments. Corporate bond opportunity funds would be at the high end of the spectrum.
Tax free bonds are another alternative. Despite the yields having fallen from when they were issued, post tax returns would be higher compared to a bank fixed deposit for a person in the highest tax bracket. Most of the issuing companies are institutions with high credit rating.

Hybrid investment options
An investor could invest into hybrid options that have combination of debt and equity. One of the most conservative options would be Monthly Income Plans (MIPs). MIPs typically have a low equity component between 10-25 per cent on an average depending on the fund that you choose. You need check the underlying equity composition before you invest. One needs to keep in mind that this is on the back of good performance of equities in this period.
One could also look for higher risk options of balanced funds or dynamic asset allocation funds. One must note that Balanced Funds have more than 65 per cent exposure to equities and are covered under equity taxation, which makes them tax free after one year of holding period.
Hybrid investment options can also be invested through systematic investment or a systematic transfer to reduce the risk, especially for higher risk options like balanced funds.
In summary, one needs to focus on options that deliver higher post tax yields to compensate for the falling interest rates on fixed deposits and small saving schemes. Such periods also pushes you to take a higher risk level. While investing in higher risk avenues, keep in mind that they could be volatile and even deliver negative returns in the short run. Hence, hybrid funds with equity risk exposures that one is comfortable with are also an option to choose from. While evaluating options, ensure that you maintain a debt:equity exposure suitable to your risk profile.
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