We all need money for our routine expenses and keep it in part as cash, and balance in savings account. Over time the money in excess of monthly requirements accumulates, and we generally tend to put that money in some fixed deposits. There are also some one-time cash flows on account of arrears or increments which bloat the savings accounts balance. Most of the people are apprehensive of entering the Financial Markets, both Debt or Equity. They prefer sticking to the traditional savings and deposits instruments. Due to their general risk-free nature, these avenues are indeed good for wealth preservation and accumulation over time.
Traditional Options
Before we move on to discussing the Debt Mutual Funds, it is important to understand some peculiarities of the traditional Savings/deposits and Govt schemes. This will help us to correlate these with corresponding better options in the Financial Markets.
Holding Cash
This undoubtedly is the most preferred option for people with some sort of illegitimate wealth. However, Govt has now laid down a ceiling of ₹ 2 lakhs, and anyone in possession of more cash than that would attract penal provisions. But cash is also essential to meet our daily needs and therefore desired to be kept at some levels. There is also a tendency to hoard cash whenever any news/rumor reduces faith in the financial system.
The good part is that it is the most readily accepted medium of transaction, and accepted in each and every corner of the country. The bad part is that cash does not earn any return, and is losing value every moment on account of inflation. A ₹ 100 note after one year of 7% inflation will reduce in value to ₹ 93. The same is true for all digital wallets also which do not give any return. One should therefore hold minimum cash required after careful considerations of the nature of individual transactions.
Savings Account
Almost all of us now receive our salaries in the Savings Account and that becomes the start point of our transactions. The balance in savings account earns annual interest of about 3.5 % which we receive every quarter. Aggregate interest up to ₹ 10,000/- is also tax free under Sec 80 TTA of IT Act. Some banks might offer a higher rate also, but it is advisable to stick to the larger banks. One can see that even at 3.5 % return, the money is still losing value on account of a higher inflation rate.
The balance in Savings account should therefore be limited to the assessed requirements. This could generally be equal to a little over two months expenses for a salaried person with reasonable job assurance, and about six months expenses for others. Further, from taxation point of view, one should keep the average balance below ₹ 2.8 lakh to keep all interest earned as tax free.
Fixed Deposits
The easiest option to move excess money from Savings Account is a fixed deposit. The tenures of FDs in Banks/NBFCs varies from as less as seven days to up to 10 years. It is a convenient tool to accumulate savings with easy liquidity. However, the returns are completely taxed at applicable marginal rates (except for senior citizens above 60 yrs of age for whom combined interest earning from Savings account and fixed deposits up to ₹ 50,000/- are exempt from tax under Sec 80TTB of IT Act). Which means that up to 30 % of gains would be eroded on account of tax, and therefore the deposit would be beneficial over a savings account only if the return over savings account is greater than 30%. For eg if the Savings account rate is 3.5 %, then only deposits offering returns of over 5% would be beneficial.
Another disadvantage is that the tenures are fixed and so is the tax liability. Even if one does not need funds, he is liable for the tax on accrued interest. This aspect is important to understand the comparative advantage of Debt Mutual Funds, over Fixed Deposits.
Government Backed Schemes
There are also a lot of deposit schemes backed/sponsored by the Govt with social security objectives. You can open these with Banks, Post offices or other designated agencies. Some important ones with key aspects specific to the schemes are as under:-
Provident Fund/Public Provident Fund
All employees can make voluntary contributions to respective PF accounts up to their monthly basic pay. In addition, one can open a Public Provident Fund account also and subscribe annually up to a limit of ₹ 1.5 lakh. The prevailing interest rate is 7.1 %, and being tax free, it is one of the best options to accumulate savings along with the effect of compounding.
Senior Citizens Savings Scheme (SCSS)
This scheme is for people over 60 yrs of age, or those over 55 yrs and have retired under VRS. The minimum investment is ₹ 1000/- and maximum is ₹ 15 lakh. The interest rate witnesses periodic revisions and presently it is 7.4%. The maturity is after 5 yrs, extendable once by another 3 yrs. Investment up to ₹ 1.5 lakh is eligible for tax deduction under Sec 80 C, but one has to pay tax at marginal rates on the interest earned.
Sukanya Samridhi Yojana (SSY)
This is a must have instrument for anyone with girl child less than 10 yrs of age. The interest rate offered is highest at 7.6%. Though it is revised regularly, it remains higher than all other comparable instruments. One can subscribe up to ₹ 1.5 lakh in each yr, and for 14 years. The maturity period is of 21 yrs but subscribers can withdraw complete amount after girl child attains age of 18.
Post Office Deposits
These are similar to the schemes of the Banks but with added safety due to sovereign guarantee. These are also convenient for places which do not have adequate banking facilities. The interest rates are generally in line with the prevailing rates, revised periodically by the govt.
Kisan Vikas Patra
This is another attractive Post Office deposit scheme which is presently offering an interest rate of 6.9 %. Though the returns are taxable, the good part is that the interest rates remain fixed till maturity based on date of investment and there is no upper limit of investment. The maturity period is 124 months but withdrawal without any reduction in returns is permitted after 2.5 yrs. This is a good risk-free option in a scenario where interest rates are continuously falling.
National Savings Certificate
These are also available at the Post Office in multiples of 100 without any upper limit. The tenure is 5 yrs and the prevailing return is 6.8%. These are transferrable and can also be used as security against loan. Though investment is eligible for deduction under Sec 80 C, the returns are taxable at marginal rates.
You can find more on the Scheme Rules at National Savings Institute of India
Recommendations
There are several other options available depending on the need and convenience of investors, like recurring deposits, reverse sweep options etc. The key elements to evaluate in all options are four. Firstly, what is the annualized rate of return. Secondly what is the tax implication. Thirdly, what is the lock in period/liquidity and fourthly, how does it fare against inflation. Some recommendations based on this discussion for people who want to remain with traditional instruments are:-
(a) Keep minimum amount of cash and make maximum use of digital payments mode so that money keeps earning some returns till utilized.
(b) Do not keep a large balance in Savings account.
(c) Put money in fixed deposits only if it is giving post tax returns higher than the savings account.
(d) Make maximum use of Govt backed deposits and schemes with high interest rates and tax benefits like PF/PPF/SCSS/SSY.
(e) Post office schemes like Kisan Vikas Patra and NSC are also good options for accumulating savings at decent returns with Govt backed safety.