Investing in small saving schemes-Think twice

Bhopal-based Senjo Ramakrishnan was thrilled when the government decided to hike interest rates on public provident fund (PPF), post office savings and national savings certificate (NSC). However, a meeting with financial advisor friend, changed his perspective.

So, what prompted the delight?

From December 1 onwards, your investment in all government small savings schemes will fetch higher rate of interest. Public provident fund will now offer 8.60% instead of 8% earlier while post office monthly income scheme is available at 8.20% as against 8% earlier. NSCs are carrying 8.40% for a five-year period and 8.70% for 10-year maturity. Moreover, the investment limit in PPF has been raised from Rs 75,000 to Rs 1 lakh per annum.

All these are fully secured investments with higher returns. This is also at a time of highly uncertain equity market. Ramakrishnan, a professor by profession, was actually swayed away by both the factors!

The inside story….

“Unless you are extremely risk averse, it is not prudent to invest in small savings schemes barring PPF,” said Suresh Sadagopan, Principal planner, Ladder7 Financial.

“Under the current interest rate scenario, the tax adjusted returns in post office savings and NSC are not attractive as compared to the existing bank fixed deposits and debt mutual fund schemes like fixed maturity plan or income fund.”

Typically, PPF is considered as the exempt-exempt-exempt or EEE tax scheme under section 80C of Income Tax Act. Here, contribution, interest income and withdrawal all are tax-free. The enhancement of yearly limit too cheered income payers.

“Tax payers with higher tax bracket (at the rate of 30%) should go for mutual fund investments. Any FMP that majorly invests in instruments like public sector banks’ certificate of deposits is a preferred investment bet. This form of debt investment in mutual fund schemes gives extra security to your investment,” said Anil Rego, CEO and founder, Rights Horizons.

A back-of-the-envelop calculation suggests that an FMP offers 9.50-9.60% rate of interest for one year maturity. The tax-adjusted return would be around 7.60-7.70% with indexation (i.e. to consider the rate of inflation while calculating tax). A tax rate of 20% is applicable for FMPs with maturity of above one year.

“In an income fund, you have the flexibility to exit from your investments booking profits after one year. An NSC requires you to block your funds for five years. With the possibility of a rate cut getting brighter due to a slowdown in GDP growth, income funds are expected to generate 12-13% return annually over a period of time,” said Hiren Dhakan, associate fund manager, Bonanza Portfolio.

Rates at a glance:

Notes: 1) the rates are subject to different schemes and maturities

2) Tax-adjusted returns for FDs and NSCs vary on individual tax-brackets. We have assumed it at higher tax bracket at 30%.

*Exempt-Exempt-Exempt

Income funds invest in government securities. Once RBI starts slashing rates, the yield or interest income of government bonds will be falling. Consequently, the bond prices will rise. In 2008 when there was a series of rate cuts, some income funds had risen 150% yearly on an average.

Similarly, a bank fixed deposit scheme offering nearly 10% rate of interest will yield tax adjusted return of around 7% annually for an individual who falls under higher tax bracket. NSCs will offer tax adjusted returns of around 5.88-6.09%.