Rising rates offer you many short-term options with minimal wealth-erosion risks

The rising rates have thrown open many opportunities for the short-term fixed income investors. After the Reserve Bank of India's 50 basis points hike in the repo rate - the rate at which it lends money to banks - banks have marginally increased the rate of interest on their fixed deposits.


As we move closer to June 15, the date of the maiden advance tax payments in the financial year 2011-12, short-term rates are expected to go up further. That may make things difficult for investors, who will be faced with the problem of choosing from plenty of options.

FIXED DEPOSITS

Bank fixed deposits are attractive for short-term investors. But as the interest income earned on fixed deposits is taxed at the individual's applicable rate of tax, it is not an attractive option for all. In the case of those in the highest slab, the interest income will be taxed at 30.9%. However, FDs are not bad for all.

"The fixed deposits with nationalised banks are good investment options for investors coming from low income groups and especially senior citizens with low income," points out Abhishek Gupta, chief executive officer and founder of Moat Wealth Advisors.

Bank fixed deposits can offer you a pre-tax return of around 7% to 9% for tenures of more than three months but less than one year. If you are with a nationalised bank, it is as good as a sovereign guarantee. So, if you are looking for peace of mind and some returns, you can consider such deposits. Investors also do come across six-month company fixed deposits, which offer good yield.
But most experts point out that companies may be offering 10% per annum on such deposits because they be cash strapped. Unrated company fixed deposits entail higher risk for investors. If you are looking for higher returns, it is better to look at mutual funds.

FIXED MATURITY PLANS

Though banks offer 7% to 8% per annum on a 91-day fixed deposit, they are forced to borrow at over 9% in the money market due to the tight liquidity conditions. The banks offer a rate in the range of 9.4% to 9.75% on a threemonth certificate of deposit to institutional investors participating in the money market. A oneyear certificate of deposit, on the other hand, offers in the range of 9.8% to 10%.

The most cost-effective way to invest in a certificate of deposit offering such a high yield is through mutual fund. If you are sure about the tenure you are willing to remain invested in and if you will not need the money midway, you may be better off considering investment in a suitable fixed maturity plan (FMP). FMP is a closed-ended debt scheme investing in fixed income instruments that mature on or before the date of maturity of the scheme.

On the date of maturity, the scheme is liquidated and the proceeds are distributed to investors. The scheme does not take interest rate risk. You may come across FMPs offering tenures of 91 days, 180 days and one year. Though no FMP tells you how much returns it will offer, you can get an idea of the yield by looking at the prevailing yields in the market.

Even if you keep aside 50 to 75 basis points for the fund house towards expense, you are still left with a good return. For FMPs of less than one year, it makes sense to opt for the dividend option. The dividend announced by these funds attract a dividend distribution tax of 13.52%, which makes the post-tax returns attractive compared with the interests received on fixed deposits, which are taxed at 30.9% if you are in the highest tax slab.