As recently as 2013, the interest rates on Bank FD’s were as high as 9% per annum for a 5-year term. Since then, as the fiscal deficit has reduced, there have been rate cuts across the board from the RBI, and Banks have correspondingly reduced the interest rates on their FD products to the point where some are offering a mere 6%, which is closer to the interest rate you get for letting your money lie in the Savings account, where at least it is easily accessible.
In theory, this is a good thing, freeing up liquidity by incentivising investment rather than putting of funds into illiquid assets. But the interest on Bank FD’s is an essential part of the income for a lot of people, mostly senior citizens, who depend on it for meeting day-to-day expenses. This means that one needs to look for alternatives, and that road eventually leads to Debt Mutual Funds, which offer a similar alternative, but with the promise of higher returns. Debt Mutual Funds are also more beneficial from a tax perspective if you are taxed at anything higher than the 10% slab.
But returns are not the only criteria, and while we have covered the subject of what Debt Mutual Funds are elsewhere, let us today look at a comparison between them and Bank FD’s, from a risk perspective.
Safety of Capital
Bank FD’s are underwritten by the government to the extent of INR 1 lakh. In case of a Bank failure, your FDs are protected only to that extent. Bank failures are, of course, quite rare, particularly for the larger private-sector banks (ICICI, HDFC, Axis etc.) or the PSU Banks (SBI, Bank of India, Union Bank of India, Bank of Baroda etc.).
In case of Debt MF’s the safety depends on the instruments it invests in, and this is why selection of scheme matters. Debt MF’s invest in the following categories of Debt instruments:
a) Government Bonds: These come with a Sovereign Guarantee, and are considered safer than Bank FD’s for the full amount of investment.
b) Bonds and corporate FD’s of ‘AAA’ rated companies / banks. While these are considered very safe, your personal risk perceptive might vary depending on how reliable you find rating agencies in India.
c) Bonds and corporate FD’s of lower-rated companies, which can go all the way down to ‘C’, though it is unlikely a MF will invest in anything lower than an “A”.
Managing your debt portfolio
What the above means to an investor, really, is that s/he needs to be aware of where a Debt MF is investing. Fund AMC’s release details of their investments as well as the break-up of their investment across risk categories. Be aware of what these are and where your money is ultimately being applied.
Further, monitor the risk-return profile. If a fund has been giving good returns by investing in lower-grade securities, it is possible the performance may not be sustainable over a period of time, due to the possibility of default. Keeping a small portion of your portfolio in such schemes is not a bad thing, in fact it can give just that little ‘icing on top’ to a portfolio, but do not be tempted to put the bulk of your funds into high-risk schemes.
Conclusion
Debt Mutual Funds are an excellent alternative to Bank FD’s in a low-interest-rate environment. They provide comparable, if not better, returns, are tax-advantageous and more liquid than Bank FDs. At the same time, an investor must remain aware of the implications of investing in a Mutual Fund, which is that they will always be subject to some form of risk. Therefore, monitoring of the risk profile of your Debt Mutual Fund portfolio is always advisable.
