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
