When interest rates are low, how to make money in the fixed income space?

NEW DELHI: Mortgage lender HDFC has just reduced deposit rates on medium-term investments to the lowest in 43 years. Deposit rates on a 66-month investment fell 20 basis points to 6.25 per cent from 7.75 per cent a year ago, reflecting the squeeze on returns in fixed income assets.

Falling returns on fixed income assets have created a conundrum for risk-averse investors and retired employees, who fall back on such products to generate regular income. In a high inflationary environment, such low returns on assets tend to erode capital and, thus, dwindle the asset base.

However, wealth advisers say it’s not really a hopeless situation, and the fixed income space still offers a plethora of attractive investment options. Just that one needs to walk through a labyrinth to figure out which product suits one’s needs and risk profile best. The right investment option can make one a lot of money, while the wrong one can spell disaster.

Which product suits you?
So, which fixed income product can help you make money in the current environment of low interest rates, increased default risks and ever more importance of cash?

Wealth advisers say it all depends on your individual income-tax slab. “A lot of choices in the fixed income space will depend on the tax bracket an individual investor falls. While high quality corporate deposits or bank deposits or even postal savings schemes are good options for people in the lower tax bracket; tax-free bonds, short-term debt funds and dynamic debt funds can be better alternatives for people in higher tax brackets,” said Vishal Dhawan, Founder & CEO of Plan Ahead Wealth Advisers.

Don’t lose sight of common options
Dhawan said investors who are not using their tax exemption limits in public provident fund (PPF), voluntary provident fund (VPF) and Sukanya Samriddhi Yojana to take a serious look at these products. “They provide returns in the vicinity of 8 per cent currently, but have lock-in periods,” he said.

These long-term schemes run by governments and financial institutions are extremely safe, provide superior returns and come with multiple tax benefits.

Investment mantra: Safety first
Wealth advisers say safety of investment is of paramount importance in fixed income assets, so one should not run after more returns just for the sake of it.

“The main objective for investing in fixed income assets is to avoid risks. Sometimes people get tempted with something that may give one per cent extra return, but they do not evaluate the risk involved in chasing that extra return. If you do not understand a risky investment tool, it’s best to sacrifice that extra return and be in products that will get keep your money safe,” said Lovaii Navlakhi, Founder and CEO, International Money Matters.

Navlakhi recommends a conservative approach, given the uncertain economic situation, and advises people to invest in corporate debt funds, which hold mostly AAA-rated papers for shorter term. Those with a longer time horizon can look at G-Sec, he said.

Count your tax slab
Cash flow or immediate need for cash are important, and hence, the options may vary for salaried investors and retired people.

“For a person with a job, generating an income is not the key concern. So, it will depend on the income-tax slab, as FDs and small savings schemes may not be suitable for those in the higher tax slab. I would suggest select debt funds for them. If the person is elderly, my suggestion will be NPS,” said Suresh Sadagopan, Founder & Principal of Ladder7 Financial Advisories.

For those with a shorter investment horizon, Sadagopan recommends only mutual funds. “An arbitrage fund or a shorter tenure fund can give slightly better pre-tax returns. Moreover, they also have greater liquidity than bank FDs,” he said.

“Typically, I would avoid products where taxation will be at the income-tax slab level. Because for someone in the 30 per cent tax bracket, 7 per cent return on a bank FD will result in less than 5 per cent real return,” Sadagopan said.

Bear with inflation for now
As RBI is doing all it can to keep interest rates low even as inflation, which eats into your money’s worth, has hit an eight-month high of 7.34 per cent, bank fixed deposits have become unattractive. But analysts say one should not be discouraged by that.

“Inflation, which is there currently, may not be at the same level once the base effect comes in early next year. So, while bank FDs may not be inflation-beating today, that reality may soon change. Therefore, investment decisions should not be made looking at the current inflation rate. People should keep in mind to not lower the quality of a portfolio trying to get higher interest rates. It is still not advisable to take higher risk to get higher return. If a mutual fund has higher exposure to lower-rated bonds or credit risks, it is not worth taking that higher risks,” Dhawan said.

What about corporate FDs?
For a person who wants to move beyond bank FDs, does it make sense to go for corporate fixed deposits, which give better returns. Analysts say, “Yes, but there is a caveat.”

“You can invest as long as you understand the risks in corporate deposits. Just because a company is rated higher or has been in the business for many years, it may not be good enough. It will be important to see which industry it belongs to and how has been its business growth in these challenging times, because ultimately it will have an impact on the deposits and deposit rates,” said Navlakhi.

Dhawan advises investors to stick to high quality AAA-rated paper in the corporate FD space. Top rated companies like HDFC, Mahindra Finance, Bajaj Finance and LIC Housing Finance are offering returns in the 5.5-7.5 per cent range on deposits for one year, which is more than the 5 per cent returns that top banks are offering on FDs currently.

Corporate deposit schemes run a default risk, which has heightened in the wake of the pandemic, as companies go through severe stress.

“The risk in fixed income comes from single ownership. Single instruments, single company and single sector-focused fund managers are at risk. If I put my money in one company, say ILFS, I either get zero return or all. So if you are putting your money in corporate deposits, make sure the amount is not so much that it can impact you gravely if there is a delay or payment default,” said Navlakhi.

Three things to avoid
Suresh Sadagopan advised investors to avoid the following things in the current environment:

  • Do not chase fads: When gold prices were going up, everyone was chasing the yellow metal. If you really want to create wealth, asset allocation has to be in place, you cannot keep on running behind what is doing well.
  • Don’t dwell too much on returns: Safety of money is more important right now than what returns you are getting. It is not worth taking that extra risk for an additional buck.
  • Ensure liquidity level: Keep the liquidity intact in banks for emergencies; don’t trust every investment product to stay liquid all the time.

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