InvestorQ : What is your view on shifting money from bank FDs to short duration funds? My financial advisor has been suggesting that to me.
prachi Patwardhan made post

What is your view on shifting money from bank FDs to short duration funds? My financial advisor has been suggesting that to me.

Answer
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2 years ago
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Your advisor surely has a point because bank FD rates are falling and could fall further as raters are cut. Now banks have moved to external floating rate benchmarks and so deposit rates will fall in tandem with the lending rates to clients. There is the option of small savings which offer higher rates but they come with a lock in. Hence FDs could become increasingly unattractive going ahead. More so, since FDs pay interest that is taxable and hence these costs will further reduce your post tax returns on FDs. Here is how you can strike a fine balance between risk, returns and liquidity.

First, let me talk about the emergency fund that you would typically require over the next 3-6 months. In this case, the short duration fund could become a risky proposition. These funds can be parked in liquid funds or overnight funds. They would still yield higher returns compared to a bank deposit and also they are more tax efficient. Secondly, the balance money after considering your emergency requirements can be invested in short-duration mutual fund schemes investing for one to three-year time frames. You must be very clear that you don’t require the funds for this time period. In this case, you get higher yields compared to fixed deposits without compromising on quality. Of course the assumption is that you only invest in funds with a portfolio that is predominant with AAA-rated bonds.

By investing for a period of 3 years, there are two benefits you will get. Firstly, you will get the full benefit of the higher yield on the longer time frame. Secondly, these are classified as non-equity funds for tax purposes and hence you will get the benefit of LTCG. In this case, the tax rate would be 20% but you will pay the tax after considering the indexation benefit so your tax liability will reduce substantially. Ideally you should be investing in these products with a three-year time frame to benefit from the tax treatment for long-term capital gains. Do not invest in funds that do structures or very sophisticated products. These would normally entail higher market risk and also at times higher credit risk. Stick to simple long duration funds for best impact.

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