Where to park money if rates cool

The potent combination of a high interest rate regime and high inflation can leave the most prudent investor in doubt about the best investment avenues. And so it is now in India. But the expectation is that interest rates will soften sooner than later and would in turn lower deposit rates. In such a situation, retail investors would require clarity on the right investment options. DNA Investor checks out a few avenues:

Fixed deposits
Does it make sense, then, to get locked in with fixed deposits now? The answer is yes. Expecting that interest rates are going to soften, financial advisors feel that it is better to park your money in bank fixed deposits (FDs) that will fetch you good returns at the current high interest rates. For instance, the Oriental Bank of Commerce and Karnataka Bank offer the highest rate of 9.75% on 1- to 2-year FDs. Punjab & Sind Bank offers 9.5% on 3- and 5-year FDs.

Investors should choose the tenure depending upon their liquidity or interim need of money. Since the cost of premature redemption of FDs is high, the investor has to take a call on the tenure. As the central bank is expected to further cut the cash reserve ratio (which was slashed by 75 bps to 4.75% recently), the deposit rates may come down. An FD with a five-year lock-in period may give you tax benefits as well.

“Liquidity of investors matters a lot when they decide the lock-in period. If you have money to spare for a specific period, then they can choose the tenure accordingly,” says Suresh Sadagopan who runs Ladder7financial services.

Fixed maturity plans
Fixed maturity plans (FMPs) are now one of the top picks in the debt basket. FMPs are closed-ended debt schemes with a fixed time horizon that can vary from a month to anywhere between one year and two years. Some schemes can also go up to even five years. These are debt instruments with a fixed maturity date; they invest in debt and money market securities whose maturity coincides with the fund’s maturity date.

Experts point out that FMPs are most favoured in the months of February and March (toward the financial year-end). For instance, 94 new funds were launched in February alone, swelling the total number of fund launches in 2011-12 to 719.

This is because investors rush to make the most out of the double indexation benefit that these instruments offer. Jayant Pai, head of marketing at PPFAS AMC, says that the advantage of double-indexation sets in if the instrument is held for more than a year. “If you buy an FMP in March 2012 (FY2011-12) and sell it in April 2013 (FY 2013-14), then you can avail tax benefits for both FY12 and FY14.”

Pankaaj Maalde, head of financial planning, Apnapaisa.com, gives a thumbs-up to investment in FMPs but cautions that “before investing in any FMP, you should take a look at the papers that the company is planning to invest in. A check on the kind of investments made by the company in previous plans also gives a fair bit of idea about where it is going to park its money. In fact, one should try and invest in AAA-rated funds”.

The returns are not disclosed by companies but generally managers share indicative returns.

Debt mutual funds
“When you are not sure about the requirement of money in the interim, then it is better to choose debt mutual funds instead of other instruments, since these instruments do not have a lock-in,” says Jayant R Pai of PPFAS.

With interest rates expected to soften, it is better to go in for options with longer maturity. As a general rule, debt instruments with longer tenure may benefit more during a reversing interest rate cycle and vice-versa.

Gilt funds outperform other avenues. These funds usually invest in government securities and corporate bonds.  As interest rates fall, yield of your portfolio goes up.

“At the shorter end, rates are looking extremely attractive right now. These are poised to fall over the next three or four months, whether or not the RBI eases rates. For, there won’t be any liquidity and year-end refinancing pressures by then. In that sense, short-term bond funds and products anchored around 1-year rates would make a lot of sense,” says Suyash Choudhary, head of fixed income, IDFC Mutual Fund.

Liquid funds; ultra short-term funds
Liquid funds are debt mutual funds which invest your money in short-term money market instruments like certificate of deposit, commercial paper and treasury bills, all of which have maturities of less than a year.

Pure liquid funds and liquid-plus funds (which come with a longer tenure) are the two kinds available under this category.

Returns are tax-free in the investor’s hands, if the dividend option is taken. There is a dividend distribution tax of 28.33% on liquid funds and 14.16 % on liquid-plus funds. Experts feel that these may suit evolved investors and not novice retail investors.