When it comes to investment options, most savers default towards bank FDs. Outside of gold and real estate, FDs remain most favored. Barring the fact that they are simple and safe, they do not have much else on offer.
In a falling interest rate scenario and sticky inflation, FDs are not viable. Besides, from a tax perspective too, FDs turn out to be sub-optimal. For example, for the highest income tax bracket, post-tax real returns on an FD would be just 4-5 %. So what are the other investment avenues available to the retail investor?
While Real Estate and Gold have been popular since time immemorial, they are losing their sheen due to restrictions on holdings, low viability and poor liquidity. Commodity investments are a more recent phenomenon aided by the spread of financial derivative products listed on multi-commodity exchanges. Currently, futures trading is available for a multitude of bullion, metal, energy, oil and agri products.
|Real Returns||Low moderate||Low||Moderate|
|Risk (returns)||Moderate||High||Very high|
|Min. ticket size||Very high||Low||Moderate|
* Tax considerations are very complex. Treatment of rental income depends on number of properties owned. Sale consideration is exempt only if reinvested in real estate or specified bonds with myriad conditions.
The two primary categories within financial assets are fixed income and equity.
Various alternatives to FDs exist on the fixed income side. Small Savings Schemes (SSS) consist of PPF, Post Office Savings, National Savings Certificate, and other schemes specific to girl child, senior citizens, etc. Tax-free bonds issued by PSUs or eligible agencies also provide a safe and simple alternative. Debt Mutual Funds invest their corpus in slightly longer term corporate bonds, which exposes them to credit and liquidity risk and returns are subject to significant volatility. Liquid Mutual Funds invest in shorter duration securities that are not subject to as much volatility but are subject to moderate levels of credit risk. Fixed Maturity Plans (FMPs) invest in bonds, securities, deposits of corporates for a fixed duration and pay out the proceeds to the investor at the end of that duration. The approximate yields are known upfront and locked in for the duration of the plan. Income on sale of Mutual Funds and FMPs is not taxed as interest but as capital gains, making them more tax-efficient than other interest paying alternatives.
The table below provides a summary of the various fixed income alternatives. In this, inflation is assumed to be around 4%.
|Parameter||SSS||Tax-free bonds||Debt MFs||Liquid MFs||FMPs|
|Real returns range||4.5-5%||4%||7-7.5%||4.5-5%||5.5-6%|
|Risk (returns)||Very low||Very low||Moderate||Low||Very low|
|Safety||Very high||Very high||Moderate||Moderate - high||Moderate|
|Tax efficiency||Tax free||Tax free||High||High||High|
|Min. ticket size||Vey low||Low||Low||Moderate||Low|
These investments have inherently unpredictable returns. However, if appropriately chosen and adequately diversified, the long-term rate of return is much higher than that of fixed income and physical assets. As an indication, the 30-year CAGR on the BSE Sensex is 17%. In the absence of experience in equity investing, it is best to rely on a professional investment advisor.
|Parameter||Equities||Equity ETFs||Equity MFs|
|Real returns range||12-15%||12-15%||10-13%|
|Safety||Moderate||Moderate - high||Moderate - high|
|Liquidity||Moderate (company specific)||High||High|
|Min. ticket size||Low||Low||Low|
Within equity linked, another avenue is subscription to equity of new companies. This can be done through the initial public offering (IPO) of the company or even pre-IPO via private equity / venture capital funds.
Unit linked investment plans (ULIPs) are a hybrid option that combine insurance and investment and within investments, offer the flexibility and convenience of switching between fixed income and equity plans.
A part of the premium paid by the investor is utilized towards the insurance cover while the remaining portion is invested in various equity and debt schemes. Investors choose the type of funds – debt, equity or hybrid - based on their risk : reward appetite and then have the option to change allocations during the tenure of the plan.
However, unlike term insurance, ULIP schemes have a list of applicable charges that are deducted from the payable premium. Initial administration charges as well as surrender/withdrawal charges vary from insurer to insurer so do ensure you ask about them beforehand.
Related: ULIPs Demystified
Indian markets have evolved considerably post-liberalization and so have options for investors. Thinking beyond the obvious will not just optimize returns but also risk, thereby creating an effective asset allocation for the investor.
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