While
passive investors can still park funds in post-office schemes, those looking to
maximise gains will have to be more nimble on their feet.
Come December 1,
post-office savings products are set to offer higher interest rates. While this
announcement has been cheered by investors, it may be premature to rejoice
based on this proposal alone.
First, if you have
read up a bit more, you would know that these new rates are not really ‘fixed'
for many years, as was the case so far. The interest rates for a five-year time
deposit, for example, will no longer stay put at 7.5 per cent. A new rate will
be announced on April 1 each year, and this rate will be linked to the average
yield on a five-year government security during the previous calendar year
(actual rate will be 25 basis points higher than average yields).
Today, the proposed
rate on a 5-year deposit is 8.3 per cent. But it so happens that these changes
have come at a time when market interest rates may be at their peak, making the
picture look rosy. If market rates plummet later, so will the interest rates on
your post-office savings.
Wind out of popular
schemes
This is not the
only tweaking these products have undergone. Other changes may force investors
to reconsider whether they are still attractive at all. Consider the Monthly
Income Scheme (MIS). As on March 31, 2011, MIS (outstanding of about Rs
2,18,674 crore) were the top small-savings product, constituting 35 per cent of
the total outstanding of all small savings schemes put together. Aside from
being popular for providing a steady stream of cash-flows every month from an
initial investment, the MIS is considered an alternative to bank fixed
deposits. For example, an investment of Rs 4,50,000 (upper limit) in an MIS, at
8 per cent, brings in Rs 3,000 interest every month. If this interest was
invested in a post-office recurring deposit (RD) giving 7.5 per cent interest,
the gain at the end of a six-year tenure, along with a bonus of 5 per cent,
works out to Rs 49,254 per annum, or a return of 10.94 per cent (pre-tax).
Thus, this proved
to be a good alternative at all times for people who had surplus cash to
invest. More so, when long-term fixed deposit rates were much lower. Now, apart
from the fact that the interest rates will change every year, there are two
other changes to this scheme. One, the tenure is reduced to five years. Two,
the bonus component is out. An immediate check at the current MIS (8 per cent)
and RD (7.5 per cent) rates but with a five-year tenure and no bonus shows that
the return from a MIS plus RD strategy falls from almost 11 per cent earlier to
only about 8 per cent now. Besides, investors will also have to brace for
year-to-year volatility, not only in the MIS rates but also RD rates.
Even if you lock
into an MIS at an attractive rate, such as the proposed 8.2 per cent, returns
on your recurring deposit investments from this cannot be locked in and will
vary each year, making your ‘effective return' calculation go haywire.
Similarly, the
Kisan Vikas Patra (KVP), forming 25 per cent of the total outstanding as at
March 2011, has been another popular scheme.
Kisan Vikas Patra
Attributes such as
free transferability, no limits on total investment, absence of TDS (tax
deduction at source) on the interest amount, in addition to a promise of
doubling investment in eight years and seven months, made KVPs an instant hit.
Investors with income below taxable limit didn't have to worry about filing a
return to claim refund of the TDS. But a wide usage of the KVP for parking
unaccounted money, (given its opaque nature) has prompted the government to
discontinue the scheme.
The withdrawal
nevertheless narrows the choices for genuine investors, especially seniors,
looking for risk-free investment options, which also promises good returns.
There could, however, be a small window of opportunity in the next two days. As
all the changes will take effect only on December 1, KVP sales would be
discontinued only from November 30.
Calls for active
money management
To give you the
choice to pull out your money, schemes like the MIS, Senior Citizens' Savings
Scheme, RD and time deposits already allow premature closure /withdrawal with a
penalty. Now, with interest rates set to become volatile, you may be forced to
take stock more often if rates turn really unattractive.
For example, if the
MIS returns are unattractive and you can take some risk, you can consider
investing at least a part of the amount in MIPs (Monthly Income Plans) of
mutual funds. Offering a monthly dividend payout, these funds invest in short-
and long-term fixed income instruments issued by governments or corporates,
debentures and commercial paper. They also have a 15-20 per cent exposure to
equities to provide some push to your returns (with additional risk!).
On that note, to
enable you more actively manage your money, the government has lowered the
burden on withdrawal of 1, 2, 3 and 5-year deposits. Premature withdrawal will
now be allowed at a one per cent lower rate (2 per cent lower earlier) than the
time deposits of comparable maturity. For premature withdrawals between 6-12
months of investment, Post Office Savings Account interest of 4 per cent (nil,
earlier) will be paid.
There is also an
interpretation that for schemes that require recurring investments, such as the
PPF, every year's investment would earn the same year's rate of interest
throughout the tenure of the PPF. If this is valid, it would make sense to
invest the maximum possible amount when the PPF interest is high at 8.6 per
cent from December 1- March 31, 2012 and then take a call on how much to invest
the following year, based on the rates offered. This, again, calls for active
management.
Saving for
retirement
The new rules,
however, seem to discourage liquidity for PPF, having raised the interest rate
on loans from PPF from 1 to 2 per cent. This may be because the government
wants people to look at it from a ‘saving for retirement' point of view. This
is supported by the fact that the annual ceiling for investment in PPF has been
raised from Rs 70,000 to Rs 1,00,000.
Two other facts
also show that the government is trying create a ‘social security' net. One,
the proposed introduction of a 10-year NSC instrument. NSCs, again, are locked
in and don't generally provide a premature encashment facility. Two, the higher
spread for the interest rate on this new NSC ( 50 basis points over g-sec
rates) and the Senior Citizens' Savings Scheme (100 bps spread)
In all, passive
investors looking for a reasonable risk-free return, can still park their funds
in post-office schemes. But those investors looking to maximise returns or beat
inflation will now have to be more nimble on their feet.
Still attractive?
Investors will feel
the pinch from fluctuating interest rates more when the tax impact comes into
the picture. Interest on the Monthly Income Scheme, Recurring Deposit, Time
Deposits and Senior Citizens' Schemes (SCSS) are all taxable, and at times when
interest rates are low, the post-tax returns will be even lower.
Unlike the 5-year
time deposits and SCSS, the others don't qualify for deduction on initial
investment under Sec 80C of the Income Tax Act. That said, even this will
change under the Direct Taxes Code (DTC), which is expected to replace the
Income-Tax Act from April 1, 2012. The SCSS scheme could then become less
popular. Not only will the interest rates offered fluctuate from year to year
and the interest be taxed but the deduction under Section 80C will also not be
available.
Similarly, for the
5-year time deposits and the NSC, the 80C deduction will not be available under
the DTC. Moreover, although interest on NSC is taxable every year, it is
considered as a reinvestment and eligible for deduction currently. Once the DTC
comes in, interest on NSC will also fall into the tax net.
All this is in
addition to the reduction of the tenure of NSC from six years to five years,
which could itself curtail the interest outgo. Assuming that the new 10-year
NSC scheme will have the same product features as the existing one, its
attractiveness remains to be seen as, historically, all these have become
popular because of their tax benefits.
Fluctuating
interest rates notwithstanding, the Public Provident Fund (PPF) appears to be
attractive for those looking for long-term investment avenues.
Along with
government PFs, recognised PFs and pension schemes administered by PFRDA, the
PPF will continue to fall under the EEE method of taxation (i.e. no tax at the
time of investing or on returns or the final proceeds) under the DTC, providing
scope for overall returns to be higher.
Information supplied by Shri P K Patra, PM, Puri HO quoting businessline.