My retired Tauji, my father’s cousin brother, was in for a shock when he went with my cousin to renew his non-cumulative 5-year-old fixed-deposit.
The deposit rate offered to him was a mere 6.20% (including the added interest of 0.60% applicable for senior citizens) for a deposit of more than five years. It was a drastic 31% drop of 2.80% from 9.00%, which he got on a 5-year deposit in 2015!
The back of the envelope calculations showed that he stands to lose Rs. 2,800 annually, for every one-lakh rupee deposit. It means an Rs. 28,000 hit annually, for a deposit of 10-lakhs; Rs. 42,000 for 15-lakhs; and Rs. 56,000 for a 20-lakh deposit.
For a retired but independent and upright, person a loss of annual income by more than thirty percent was nothing less than a punch below the belt.
Since he retired in 2011, he never thought that he would need anything more than his safely deposited retirement corpus’ interest income. He did not have any rental income either, as he preferred investing in his children’s education to building property or buying gold.
Why are interest rates falling?
The fall in interest rates is not sudden and due to the COVID-19 economic stress. They have been declining steadily for the last 4-5 years. 2015 was the last time that deposit rates were more than 8% for any term above the 1-year.
The decline in interest rates was gradual and went with manageable inflation. Like my Tauji, it made people oblivious to the fact that interest rates follow a cycle of up and down. The only thing uncertain is the timing and the quantum of the movement.
The COVID-19 pandemic forced global central banks to reduce their policy rates, to stimulate economic activity, once again to near zero or even sub-zero levels.
Similarly, RBI took aggressive actions to supply liquidity in money markets to tide over the pandemic stress.
Some of these actions aimed to restore confidence after the failure of many prominent NBFCs and banks – IL&FS, DHFL, PMC bank, and Laxmi Vilas Bank are some examples.
RBI’s Monetary Policy Committee (MPC), in its latest meeting on December 3, 2020, kept the policy rates unchanged and suggested they will keep an “accommodative stance” in the future.
The repo rate (at which banks borrow from RBI) and the reverse repo rate (at which RBI parks funds from banks) were unchanged at 4% and 3.35% levels.
RBI also suggested that its Long-Term Repo Operation or LTRO policy would continue and expanded to cover more stressed sectors. Under the LTRO, banks can borrow from RBI at current historic low repo rates for one to three years.
Both actions signify that RBI is pushing for growth over inflation concerns in the short to medium term to pull the economy out of a recession.
Impact on saving and investments
The banks usually have the CASA (current and savings account balances) as the prime source of cheap funds. But with RBI supplying cheap money, they are forced to reduce their lending and deposit rates.
Interest rate fall acts as a general mood dampener for investors, savers, and retirees. It results in a drop in incomes, some even below the sustenance levels, and yields on safe investments.
The interest rates on a savings-bank account have dropped for the first time below the sentimental 3% mark and hover around 2.70%. Similarly, the interest rates on fixed deposits have reduced to 5.40% for depositors under 60, which is way below the 6.93% inflation rate in November 2020.
It will not be easy for anyone going forward, as the continued rate suppression by RBI will stoke it further.
But it will be particularly challenging for those living off their interest income in coming quarters, if not years, as they will face a double-edged sword – falling interest rates and increasing inflation.
Investors – especially retirees, pensioners, and people going to retire this or the next year – are scrambling for safe and steady avenues to get a fixed-income from their retirement corpus.
Even the working-class people in age groups under 55-years need to reconsider their debt allocation in these turbulent times and find a safe, long-term, and growth-oriented strategy to rebalance their portfolio.
According to ValueResearchOnline.com, many debt funds, investing in government bonds, quality corporate, and PSU papers, returned more than 9% percent in 2020. But as the famous adage goes, never chase historic returns.
Post-office Savings Schemes
The India Post, a unit of the Government of India, offers one of the best and safest savings options for the depositors of all income classes and for all life goals. It also runs the India Post Payments Bank, which works on the same commercial principles as any other bank.
But the parent India Post still offers the most competitive interest rates ranging from the 4% simple interest (SI) on the savings bank accounts to the 7.4% on the Senior Citizens Savings Scheme (SCSS) or the 7.6% on the Sukanya Samriddhi Account Scheme (SKSS) for the girl child.
Its other deposit schemes have interest ranging from the 6.7% annual interest on the 5-year term deposit to the 6.6% on the Monthly Income Scheme (MIS), where you deposit a lump sum to get a monthly income from the deposit.
Post offices also accept the long-term public Provident Fund (PPF) deposits on which the PPF organization (backed by the government of India) offers 7.1% annual interest. There are schemes like the Kisan Vikas Patra (KVP), National Savings Certificate (NSC), and the recurring deposits with maturity and interest rates of 124 months & 6.9%, 60 months & 6.8%, and 60 months & 5.8%, respectively.
High-yield savings accounts
Some new-age banks like Au Small Finance Bank and Bandhan Bank provide an interest of 4% to 7% on savings accounts with different deposit limits and features. These are anywhere between 48% to 160% higher than the Sb interest of 2.70% from SBI!
Bandhan Bank and Au Small Finance Bank are robust in their fundamentals. Yes Bank, now under the joint new management of SBI, ICICI, HDFC, Axis, Kotak Mahindra banks, is now stronger than ever.
Most banks now offer higher interest if you have opened a sweep-in facility linked to your savings account. Whenever the balance in your savings account goes above a threshold, say Rs. 50,000, the bank will automatically convert their higher savings into short-duration FDs, earning higher interest income.
If your balance drops below another threshold, say Rs. 10,000, then the FD is automatically swept-out, and the principle with interest is credited to your savings account.
Government Bonds and Gilt Funds
As ETFs are tradeable on stock exchanges and mutual funds allow same-day withdrawal on these bonds, they are also highly liquid. You can sell them whenever there is a need and withdraw funds.
As the interest rates fall, the yield on them increases, and it currently stands at more than 5% on bonds over 4-year maturity and goes up to 6.5% for the maturity of 10+ years.
But the top funds investing in these have returned more than 11.40% and up to 13.34% in the past year. The top funds in this category are ICICI Prudential Constant Maturity Gilt, IDFC Govt Securities, SBI Magnum Constant Maturity, and DSP 10Y G-Sec funds.
Also, Check- Gilt Funds- Should I Invest?
If you can park some of your investments in riskier assets for a possible better return, the high-yield bonds funds and ETFs are other options. We will never suggest you invest only in these funds for higher returns, but only 5-10% of the corpus gives that extra thrust.
Credit risk funds are aggressive and invest up to 65 percent of their portfolio in low-quality high-yield debt securities from corporates. Top 5 credit risk funds in this category – HDFC Credit Risk Debt, ICICI Prudential Credit Risk, SBI Credit Risk, ABSL Credit Risk, and Axis Credit Risk – funds earned yields of 10.22% to 11.39% in the past year (as of 1-Jan-2021).
If your 5% corpus earns 11% annual returns and 95% corpus earns 6% returns, overall returns can be 6.25%. With a 10:90 allocation in credit-risk and safer instruments, this return can be 6.5% – an extra 0.25% income with a 5% allocation in riskier assets.
Also Check: Risk in Debt Mutual Funds
Fixed Maturity Plans (FMP)
An FMP is a mutual-fund counterpart for a bank FD. You can only invest in these close-ended funds when the NFO comes out and get a lump sum payout on maturity. The difference between these and bank FDs is that the yield on the latter is pre-determined and fixed.
FMPs invest in fixed income debt instruments with their maturity aligned, having the same tenure as the scheme. FMPs help investors guard against a sudden drop in the interest rates by locking in prevailing interest rates.
Top FMPs from Nippon, IDFC, and UTI fund houses gave returns upward of 4.5%, with the top-two going above 6% yield. The problem with FMPs is the lock-in and lack of liquidity.
Normally we don’t suggest mixing insurance & investment but in the current scenario, if you are close to your retirement & in a higher tax slab – a few of these policies are good options. HDFC life Sanchay plus like policies are still giving 6% tax-free returns.
Hybrid funds invest in equities and bonds in differing ratios depending on their approach – aggressive, balanced or conservative.
Aggressive hybrid funds can invest up to 65 to 80% of their portfolio in equities and the rest in debt. For balanced funds, it is 40:60, 60:40, or 50:50; and for conservative funds, it is usually 25:75 for equities and debt, respectively.
Depending on your risk profile, investment horizon, and ability to withstand market volatility, you can add any of these to your portfolio for an investment horizon of at least 3+ years.
The top-performing aggressive hybrid fund was Quant Absolute, with returns of 38.01% over the last year. Tata Young Citizens Fund topped the balanced category with 22.485 annual returns, and Kotak Asset Allocator Fund the conservative variety with 25.84% returns.
All investors must brace themselves for reduced returns and be flexible in investments without compromising the safety of their capital.
The options mentioned above are all safe compared to equity and other asset class and can generate better returns than traditional bank deposits. These options include deposits, bonds, and fixed-income mutual funds with a strategy that may not work for you at other times but is best suited for these times.
Please share how you are coping with reduced interest rates – if you have any questions, add them in the comment section.