For short-term investments, FDs may not be the best option

Recently, I was at my old school alumni get together. We soon finished the standard “Do you remember the time when…” and the “Did you know that the character played by Aamir Khan in Taare Zamin Par is named after our school art teacher?” and got around to discussing what each of us had done since we last met.

I was meeting Sumeet almost after a decade. In our circles, he was known as Mr Risk Taker as far as his investment style was concerned. Knowing my background very well, he turned to me for advice.

Sumeet had always been a firm believer that equities as an investment class will always outperform other asset classes in the long run, and accordingly invested monies very systematically into equity-oriented mutual funds as well as a couple of specific stocks that he was a firm believer in.

Consequently, his investments did very well. Now, his son was set to join an Ivy League college next year, for which the fees had to be paid in six months. Consequently, over the last three months or so, he had started selling off his investments as the date of fee payment was coming closer. He was selling a pre-fixed amount every month and moving this money into safer instruments, as he did not want to keep this money in equities as the goal was nearing.

I marvelled at his planned investments — if only all my clients went about it in a planned way like him.

Then I asked him what safe avenue he had chosen to park the liquidated investments in. He proudly said he has been investing into fixed deposits (FDs), which were giving him 9% per annum. I was quite surprised as his requirement was just six months away and none of the FDs in the markets for such a small duration would offer him such attractive returns. Upon probing, he said he was buying FDs every month with a tenure of 1 year and a few days as the yield on the same was on the higher side and also offered liquidity as he could break the FD anytime and take out money without any penalty for premature withdrawal.

I was surprised to note that Sumeet had no idea how a FD worked and his bank relationship manager had advised him to invest money in FDs of over one year without even asking him when he needed the money. I also asked my friend if he had any clue about the implications if he withdrew money at the end of six months instead of the 1 year+ period that he had contracted when making the fixed deposit.

Here was my chance to correct him — and this is for all the people who are planning premature withdrawal. I asked if he knew what interest rate the bank was offering for a six-month deposit. He did not, but I did. It was 7.25%. What no pre-maturity penalty meant was that he would get this 7.25% rate per annum on his deposit without any deduction. Had there been a premature withdrawal penalty of say 1%, then on his early withdrawal he would have got an interest rate of 6.25%, which is 7.25% per annum less 1%. This was a revelation to him.

He then asked me what other options were available for such short-term investments. Well, fixed deposits (with good banks) are a great option (safe and with guaranteed returns) for short durations, I told him. But given his high tax paying status, dividend-paying arbitrage funds were also a good option. He could even look at shorter duration fixed maturity plans as well as ultra short term funds, which could give (though not guaranteed) slightly better returns than a fixed deposit — more importantly, the returns could be structured in a more tax-friendly manner.

The alumni meet ended with the usual exhortations of meeting again soon. Whether we would meet again in the next six months or so I wasn’t sure, but I knew I would get a telephone call from Sumeet soon.

Looking forward to hearing from you, buddy, and this time expect an invoice for the advice.
The writer is CEO, Apna Paisa, a price & features comparison engine for loans, insurance and investments. He can be reached at hrdna@apnapaisa.com