Why are people searching for “Alternative to Bank Fixed deposits” on Google?
The reason is quite obvious. Investors feel that interest on Bank FDs is not enough. The Fixed Deposit rates have fallen in the recent times with 7 to 7.5% as the rate offered by most banks. One has to pay income tax as well on the interest earned.
While the interest rates have gone down, the inflation continues to rear its ugly head. In that context, FDs do not deliver even in terms of protecting the value of the money. So, investors have no choice but to look for better investment avenues to earn a higher return.
Higher return is ok but that doesn’t mean any compromise on safety. Nor does it mean any additional taxes.
Where is this magic investment? What could be the alternative to the Bank FD?
Now, it would be really difficult to find an exact alternative. Some options which come quite close are:
Corporate Deposits / Debentures – Companies like L&T, Mahindra Finance, Shriram Transport Finance, HDFC, etc. issue deposits / debentures which general investors can subscribe to. The interest rates offered by these companies typically tends to be higher than a Bank FD.
Government and PSU bonds – The government and public sector enterprises, from time to time, issues bonds to finance their needs. These bonds are quite attractive for they promise the highest safety and a decent return. E.g. those offered by Tamil Nadu Finance Corporation or the NHAI Bonds.
However, in both the cases, these opportunities are not available throughout the year. Now, even if you apply for them, it is not necessary that you will get an allotment.
That brings us to yet another alternative.
Debt Mutual Funds – A debt mutual fund invests in fixed income instruments such as Corporate bonds / debentures or Government and PSU Bonds. The beauty of the debt mutual fund is that you can invest as little as Rs. 5000. Most debt funds are open-ended, which means that you can enter or exit the investment anytime you want.
Now, Debt funds come in a variety of flavours – liquid, ultra short term, short term, long term, income, credit opportunities, gilts, etc. However, this post will focus on the ultra short term fund variety.
- Read about liquid funds here.
What does ultra short term fund mean?
Debt funds essentially invest in corporate bonds, government securities and short term loan securities of corporates and/or government. These securities are issued for various time frames or maturities ranging from overnight / one day to several years.
Based on these time maturities, debt funds are categorised as money market, liquid, ultra short term, short term, long term, etc.
Ultra short term fund is the one where the ‘average maturity‘ of the investments in the portfolio is typically in the range of 6 months to 1 year.
One more aspect that deserves attention is the Modified Duration. Now you would know that interest rates and bond prices move in opposite directions. When interest rates go up, prices go down and vice versa. Modified Duration is the measure of the sensitivity of the price of the fund or NAV to the change in interest rate.
So, for example, if the Modified Duration of a fund is 0.5, it means that for every 1% change in the interest rate the fund’s value will change by 0.5%. This will work both ways – positive or negative.
The Modified Duration of the ultra short term fund has to be low, ideally, less than 1. This would make it less sensitive to changes in interest rates.
This ensures that the returns of the fund are stable. The price does not go up or down wildly in reaction to any changes in interest rates. This brings us to the question of safety.
How safe is an Ultra short term fund?
An important question. First things first. This is not safe like a Bank FD. Safety of this fund will be determined in two ways.
One, the fund should invest in the highest credit quality investments, typically AAA / AA. Those have the almost zero chance of default. In other words, high credit quality means that the borrower will honour the commitments to repay principal and interest in a timely manner.
Two, they invest only in investments that will mature in 6 months to 1 year on an average. The modified duration, as we noted earlier, is also less than 1 so they will not be very volatile, that is, they will not see too many up and down movement in prices. At any point in time, if you wish to withdraw your money, there is a reasonable chance that you will get more than what you invested.
To understand this, see the following graph of the UTI Treasury Advantage fund – an ultra short term fund in the last 1 year and 3 years. It shows the growth of an investment of Rs. 10,000 over the two time frames.
As you will notice, the growth of the investment in the fund has been quite steady in both 1 and 3 year periods.
Let’s now see how the Ultra Short Term fund overall compares with a Bank FD.
- Safety – A Fixed Deposit is completely safe. UST Fund is relatively safe.
- Liquidity – An Ultra Short Term fund is more liquid than an FD. You can withdraw your funds anytime without any loads or penalties. If you break your FD prematurely, you have to pay a penalty in terms of a lower interest rate.
- Taxation – FD interest is taxable as per your income tax bracket. With Ultra Short Term Fund, if you hold for more than 3 years in a growth option, you pay only 20% capital gains tax that too with the indexation benefit. (Read more on taxation)
- TDS: There is even incidence of TDS in case of FD interest exceeding Rs. 10,000 a year. No such thing with Debt funds.
- Returns – Ultra Short Term fund may give you better a return than a Bank FD, specially if you are in the highest income tax bracket.
For those in the highest income tax bracket – an ultra short term fund is a worthy consideration.
Some key pointers to select an ultra short term fund
If you are looking for pointers, here are some to help you pick a Ultra Short Term fund:
- Modified Duration – The interest rate sensitivity should be around 0.5 to 1.
- Investing style – High (Credit Quality) – Short (or Low Average maturity)
- Average Maturity of the portfolio should be Low or Short
- Average Credit Quality of the portfolio should be high
- Fund Size: Ideally, more than Rs. 100 crores.
- Expense ratio – Should be as Low as possible; Expenses can impact debt fund returns in a big way. An expense ratio of around 0.5% or less is desirable.
Most of this data is easily available on various financial websites, including Unovest.
Here is a list of 5 Ultra Short Term funds that you can evaluate:
- Reliance Money Manager
- UTI Treasury Advantage
- Axis Treasury Advantage
- ICICI Pru Flexible Income
- Tata Floater
Click on the name to see the detailed factsheet on Unovest for each of the funds.
Which Ultra Short Term fund are you moving your Bank FDs to?
Disclaimer: The funds mentioned in the article are not investment recommendations. Please consult your investment advisor to know what is the best fit for your needs.
Saying that more the duration, more the return may be true in theory, but doesn’t help me find a fund with more return. You could list a few funds that have higher return than ultra-short-term funds, maybe in a different blog post. For example, I found a few funds with 11% yield to maturity.