Proof-of-the-pudding of the statement ‘…the things are not completely rosy as the rate of return on some asset classes is expected to come down as well…‘ mentioned in the previous blog of this series – Impact of Demonetization on Individual’s Financial Goals is that the interest rates on bank deposits are already seeing a downtrend (refer News here)
This reduction in interest rate is going to impact the other market instruments like debt market funds (that shall see a sharp rise in their prices), fixed return instruments (rates shall come down significantly), small saving schemes like PPF/EPF (interest rates shall be lowered as these are market-linked).
The above shall in-turn impact the accumulation of funds for individual financial goals. Before looking at measures to be taken to counter this, let’s look at the impact on accumulation of fund with decreasing rate of return
Below are some of the measures that one can employ in low interest regime staring in the face of investors.
- Individuals with investable surplus could park the funds in either company fixed deposits (all of which have or are in the process of lowering their interest rates) or invest in long term debt mutual funds (that are expected to see a drop in yield thereby giving a good capital appreciation)
- Individuals without investable surplus but with regular monthly flow could opt for Recurring Deposits (refer Protecting future investments against falling interest rates blog for details on how RD can be used as an instrument to lock-in currently available higher rate of return for amount to be invested in future)
- For individuals with higher risk appetite, equity based mutual fund is expected to become darling of the market – given that there are expected to be very few avenues left for investing in future (for details, refer to next blog in this series – ‘Why Equity market should emerge as top investment destination post Demonetization?’
- Revisit asset allocation and move to tax efficient avenues to enhance the net returns
As Henry Ford said – ‘If you always do what you’ve always done, you’ll always get what you’ve always got.‘ – it’s thus time to invest differently to tide over the changes in post-demonetization era.
Tax-free bonds first hit markets in 2012. Initial investors are currently sitting on a 20%+ capital gains in 3.5 years in addition to receiving tax-free interest thrice. These are one of the best instruments to earn fixed tax-free returns for a longer duration.
View last post on another good instrument in falling interest scenario ‘Protecting future investments against falling interest rates’
Case FOR investing in tax-free bonds
- Interest paid to investor is tax-free – that’s a big advantage, especially for individuals in higher tax brackets.
- No market linked return – Interest is fixed throughout the tenure of the bonds thus providing a relief from market fluctuations
- No lock-in period – though the bonds are subscribed for a fixed duration, these are normally listed on BSE and NSE, thus providing high liquidity
- Capital Gains – High chances of capital gains as economy is currently in a falling interest rate regime. As interest rates fall, the bond value would increase thus providing an opportunity for capital gains. Latest issues of NTPC tax-free bonds (@ 7.63% for 20 years) that hit the market in September 2015 is already trading at Rs 1,050 (a 5% premium over the issue price). Even if a 1.6% inbuilt interest is covered, this translates into a premium of 3.4% over that – a decent gain in 2 months
- Decent investment limit – Retail investor can apply upto Rs 10 lacs. Investment beyond that shall be classified under HNI category and lead to a tad lower interest rate (generally 0.25% lower than the rate offered under Retail category)
Case AGAINST investing in this issue
- Annual interest payment – Power of compounding is lost as the interest is payable on annual basis, however, there are mechanisms to convert annual payments into power of compounding. These mechanisms shall be dealt with separately.
- There are instruments that have potential to earn a higher returns albeit with higher risk – Equity investment can generate much higher returns but the risk is incomparable, with tax-free bonds coming with near to zero risk, while the equity markets are highly volatile
- Lower liquidity – Though the bonds are usually listed on NSE and BSE, the traded volume is not high enough to provide immediate liquidity without some hit on the returns due to call/bid spread
In case you missed the ride earlier, here’s another opportunity to get on the bus.
NHAI is the latest Government Undertaking to come up with Tax-free Bonds (@ 7.60% for 15 years). The offer opened on 17th Dec, 2015 and is open till 31st Dec, 2015, however, the issue is already oversubscribed in all the categories except retail. The issue is expected to close by 22nd or 23rd Dec once Retail category is subscribed as well.
Do not miss this golden opportunity!!