NRE - FD vs Bond Mutual Fund

Interest rates on NRE - FD’s are on the decline; Interest rate has come down from 9-10% (during FY 2011) to 5.5-6.5% (as of July, 2017). India’s retail Inflation hit a historical low of 1.54% in June and lower inflation level would lead to further cut on the interest rate. NRE-FD rates are most likely to go down further from the current levels. Under these circumstances, an NRI investor would be better off investing in a bond mutual fund rather than NRE-FD.

Return: Bond Fund has potential to generate 2-3% higher return than bank FD

NRE-FD offers fixed return, currently in the range of 5.5%-6.5% (depending on the tenor and size of investment); Bond mutual fund return depends on the interest rate movement and has potential to generate a return of 9-10%. Bond fund can be broadly categorized into short term income funds, long term income funds, floating rate bond funds, gilt funds, and credit opportunities fund. Interest rate movement affect different bond category differently. Investors would be able to generate a 2-3% excess return by appropriate selection of bond fund.

Risk: Bond fund could be a safer bet than Bank FD

RBI’s Deposit Insurance and credit guarantee corporation (DICGC) provides a maximum insurance of Re 1 lac per person per bank  against  all investments such as saving deposit, Recurring and fixed deposit held with the bank. In India, lot of cooperative banks (ex madhavpura mercantile cooperative bank) have failed in the past and depositors have lost money with bankrupt cooperative banks; however as per my knowledge no commercial banks have gone bankrupt, but in future bankruptcy cannot be ruled out with mounting NPA levels and weak credit ratings (lower than AAA) of most commercial banks. While on the other hand, Bond mutual fund provides diversification benefit as fund invests in a portfolio of government bonds and corporate bonds (Generally AAA rating). In my opinion you would be better off investing in bond fund (diversification benefit, better credit rating) than the bank FD (concentration risk, rating depends on bank performance) purely from risk perspective.

Liquidity: NRE FD is illiquid when compared to Bond funds.

Assume Mr X invests in an NRE FD for 5 year period @ 7%; but say at the end of 3.5 years he is in need of money so he decides to redeem his FD, Mr X will lose a lot

·              NRE FD’s pay interest only for the completed year (means Mr X will get the interest for 3 years and loses the interest of the remaining 0.5 years)

·              NRE FD’s pay lower interest of the completed period (assume 3 Yr NRE FD rate was 6.5%) or locked in period (invested @7%)à Mr X will get only 6.5% (as it is lower)

·              NRE RD’s put an prepayment penalty of 0.5-1%

So Mr X would get an interest rate of 5.5%-6% for 3 completed year for the investment redeemed at the end of 3.5 years

While in Bond fund the exit load would generally be in the range of 0.5%-1% if redeemed within 1 year and no exit load for any redemption after 1 year

Flexibility: Bond fund offers more flexibility than bank FD

Bond funds allows Partial withdrawal; lot of fund houses and bond funds to choose from; can create a diversified bond portfolio easily while NRE Bank FD does not allow partial withdrawal, you will be stuck with one or maximum two banks for your NRE FD’s.

Taxation: NRE FD is tax free while bond fund returns (if withdrawn) are taxable

In bond funds, There is no tax on interest income; tax would be levied only on withdrawal/redemption. If Mr X redeems his investment within three year (short term capital gain is applicable, @ applicable tax slab) and if he redeems after three year (long term capital gain is applicable, @ 10%)

Assuming Mr X hardly has any income generated in India; then he would in 0% tax slab, so any redemption within three years would be tax free. And any redemption after three years will fetch 10% on the gain.

Assume NRE FD gives 6% return; Mr X has to generate a pre tax return 6.7% from bond fund (0.67% return would go for tax); so if Mr X deploys in bond fund which can give more than 6.7% he would be better off than investing in NRE FD @ 6%

Conclusion:

 Bond funds are better in terms of after tax return (by 2-3%), liquidity (easy to redeem), flexibility (more options, partial withdrawal facility), lower risk (diversification, better ratings) compared to NRE Bank FD.

Lot of bond funds are available, need to select an appropriate mix depending on market conditions and your investment requirements.

 I advise investors to seriously consider bond fund as an alternative for NRE bank FD, if you would like to be financially better off.

For any investment related queries/advise feel free to get in touch with me; you can reach me on 0965-65708812/91-9500151529

Retirement Planning: Balanced Fund Vs Fixed Deposit

Everyone would like to retire financially sound. However majority of the investors would build corpus for retirement over their working years by investing in fixed deposit instruments. FD return most of the times just cover inflation and thus real return (adjusted for inflation) in FD would be 0-2% and returns are taxable.

I advocate balanced funds offered by Mutual Fund Houses for retirement planning. Balanced funds invest in a mix of Equity (generally 60-70%) and bond (generally 30-40%). Equity investments aim at generating capital appreciation, while Bond investments provide capital protection and reduce fund volatility/risk.

Selected Balanced Fund Vs Fixed Deposit (Since Inception)

If an investor had invested Rs 1 lac in BSL Balanced 95 Fund in the year 1995 (at the time fund launch), his worth today would be close to Rs 56.5 Lac when compared to FD worth of Rs 5.03 Lacs; thus investment in BSL Balanced 95 fund would have made you rich by Rs 51.46 Lacs. All the selected funds have generated higher return than the FD in the long run

Selected Balanced Fund Vs Fixed Deposit (Last 5 Years)

If an investor had invested Rs 1 lac in BSL Balanced 95 Fund five years back his worth today would be close to Rs 2.15 Lac when compared to FD worth of Rs 1.46 Lacs; thus investment in BSL Balanced 95 fund would have made you rich by Rs 68,590. All the selected funds have generated higher return than the FD over last five years

Conclusion: Balanced fund with the mix of equity and bond can offer the best from both the asset class. Capital appreciation from equity & reduced risk from Bond. Selected Balanced funds clearly outperformed FD both in the short (over 5 year period) as well as long run (since Inception/fund launch)

Investor’s ability to take risk would be high when they have active income (Employed), higher income levels, longer investment horizon (still has sufficient time for retirement/essential commitment); If your current situation provides you enough flexibility to take risk then you should seriously consider putting your money work for you by investing in Balanced fund instead of FD. Plan well for happy & financially sound retirement

Feel free to place your comment and for any queries related to personal finance, you can reach me @ smartportfolioadvisors@gmail.com.