Yesterday, the country's bellwether lender the State Bank of India, slashed deposit rates by up to a further 50 bps across maturities. Per the new rate structure, SBI is now offering an interest rate of 6.25 per cent per annum on deposits made for two to three years. Senior citizen rates have been reduced by the same quantum, from 7.25 per cent to 6.75 per cent. The revised rates are applicable for all deposits and renewals being made after 29th April 2017.
If history is anything to go by, we can expect other banks to follow suit soon. With the latest CPI inflation rate standing at 3.81 per cent, a 6.25 per cent gross return is equivalent to a real return of just 0.54 per cent per annum for those falling in the highest tax bracket. Note that interest from fixed deposits is taxed at the margin, as normal income.
Low risk taking investors in India, who have traditionally relied upon Fixed Deposits as their go-to investment avenue, are obviously in a quandary. Locking away moneys for two to three years, for such a poor rate of real return goes against reason. If you're one of them, what are you to do?
First, don't let the falling deposit rates dictate your risk appetite. In other words, opting to increase the overall risk within your portfolio by increasing equity allocation purely because deposit rates have fallen, is bound to be a regrettable decision. Remember that equity markets are at an all-time high too, and not exactly in the "undervalued" territory which characterizes rollicking medium term returns. If you feel it is imperative that you change your strategic asset allocation plan to account for the lower rates of risk free return, do so in bite sized amounts - not more than 10 per cent at a time, and preferably in a staggered manner.
Second, rationalize your return expectations. Even within debt oriented mutual funds, the medium-term scope for generating widespread alpha by playing duration isn't exactly substantial. We'll quite likely see yields range bound between 6.5% and 7% in the medium term, implying that higher duration funds are unlikely to continue their recent canter over the next two to three years. In such a scenario, a return of 200 bps over and above the deposit rate is a perfectly reasonable expectation to have; implying that you should now be happy with returns of 8.25% to 8.50 per cent per annum from your debt funds.
Third, if you're already a debt mutual fund investor, consider making a structured shift away from longer duration debt funds such as dynamic bond funds and GILT oriented funds, into shorter duration funds which focus more on accruals to generate returns. Wild rate cuts are surely not on the cards in the next twelve months, given that the RBI's recent tones haven't exactly been dovish.
Make sure you invest into these debt funds with a time horizon of three years, to maximize your real returns and reap the benefits of indexation. Even an 8.5 per cent return will, assuming a 4 per cent inflation rate, work out to a CAGR of 7.6 per cent over a three-year period, after taxes. That's a good 2.3 per cent higher than deposits.
As always, make yourself aware of the risks and rewards of debt fund investing before you commit moneys to them. There are no free lunches in the investing world, and acquainting yourself with the risks involved with any investment is key to a rewarding and successful experience. A qualified Financial Advisor can help you select optimal funds that are in line with your risk appetite and investment objectives.
