Table of Contents
Introduction
Are you still parking your savings in fixed deposits?
While FDs have been a go-to choice for safe returns, today’s low-interest rates may not be enough to beat inflation.
It’s time to rethink your strategy!
In fact, with FD rates hovering around 5-6%, smart investors are exploring investment options alternative to fixed deposit that not only offer better returns but are also tax efficient and flexible.
Whether you’re seeking higher yields, tax-saving avenues, or diversification, today’s market offers a range of smarter alternatives that can outpace FDs.
Ready to explore better returns for your hard-earned money?
Keep reading to discover five smart alternative to fixed deposit that could help you grow your wealth faster than traditional FDs!
Let’s dive in!
Understanding Fixed Deposits
Fixed Deposits (FDs) are a kind of debt investment which has a predetermined interest rate and maturity date. Upon investing in a fixed-deposit, investors receive a receipt that details the amount of the FD, the interest payable, and the maturity date.
Maturity date is the date an investor will receive their money back.
Fixed deposits offer a regular income source, either monthly, quarterly or on an annual basis. The principal amount is also guaranteed and insured by Deposit Insurance and Credit Guarantee Corporation (DICGC) for up to Rs. 5 lakhs per person.
Fixed deposits have different maturities ranging from 1 week to 10 years. If you want to withdraw before the maturity period, there is a penalty for early withdrawal.
Historical Returns from Bank FDs?
A fixed deposit is the convenient and most reliable way to earn interest on your savings. In the Indian context, the interest rate on fixed deposits varies from 6.5% up to 9% in 2024.
If we look at the historical data of the last 20 years, Fixed deposits have given returns of :
Real returns from FDs are surprisingly very low for individuals who like to keep their savings in FD instead of options that are alternative to fixed deposits.
Real return is the return earned after subtracting inflation and taxation. Let us understand using the example below.
Impact of taxation:
Assuming a 20% tax is charged on the interest rate of 8%, the tax rate is 1.6% (8% x 20%). The post-tax return on the FD after tax is 6.4% (8%—1.6%).
Impact of inflation:
The average inflation rate in 2022 was 6.7%. If we take the inflation rate and reduce it from the FD returns after tax, we are actually left with negative returns of 0.30%. In other words, the investor will face erosion in the real value of his capital when investing in bank fixed deposits.
Reason to Explore Alternative Investment Options
Risk:
Fixed deposits are usually preferred by risk-averse investors whose priority is to safeguard their capital and earn inflation-beating returns. While fixed deposits yield returns higher than inflation, post-tax returns remain lower than those of other investment avenues.
FDs are highly illiquid as they have a fixed maturity date, and withdrawal before maturity incurs early penalty charges. This makes FDs prone to both inflation and liquidity risk.
If you are willing to take a higher degree of risk, you can choose to invest in market-linked instruments, while if you do not want to take a higher degree of risk, you can invest in government-backed investments.
Returns:
The ultimate motto behind investing is to generate returns and grow your savings.
FDs offer returns ranging between 5% and 8% annually, depending on the bank’s credit ratings.
Generally, investment options alternative to fixed deposit offer higher returns but come with different factors like market risk, lock-in period, age group, etc. These factors should be evaluated with respect to the investor’s investment horizon, associated risks, and financial conditions.
Investment horizon
It is not a wise decision to make all of your investments using fixed deposits. Having a diverse portfolio of investments is usually advantageous.
In this manner, investors would avoid losing out on further investment opportunities for wealth generation, especially over longer time horizons.
Let’s look at some alternative to fixed deposit for investing.
Alternative to Fixed Deposit
Debt Mutual Funds:
Mutual funds have become more famous than ever. With mutual funds’ AUM reaching an all-time high, investors are shifting their household savings to equity markets to earn higher returns than fixed deposit returns.
Arbitrage Fund:
Arbitrage funds fall under the Hybrid category of mutual funds. These funds generate returns through the price differential between the stock and futures markets and also by deploying surplus cash in fixed-income instruments. They are ideal for parking money for less than one year, with returns expectations of 7% to 9% annually.
Although it falls under the Hybrid category, taxation on Arbitrage funds is the same as that of equity taxation, with STCG taxed at 20% and LTCG taxation charged at 12.5%. p.a.
Liquid Funds:
As the name suggests, liquid funds are a type of debt mutual fund that invests in highly liquid money market instruments like treasury bills, commercial papers and certificates of deposit, which have maturity ranging up to 91 days. They are highly liquid, have no lock-in period and come with very low risk as they invest in AAA and above-rated papers.
Ultra-short and short-duration funds:
Similar to liquid funds, ultra-short-duration and short-duration funds invest in debt instruments with maturities ranging from 6 months to 1 year and 1 year to 3 years.
These are alternative to fixed deposits for investors who invest in FDs ranging from 12 months to 35 months.
Long Duration & Gilt Funds
Long-duration funds are debt mutual funds that mainly invest in bonds with a maturity greater than 7 years. With a declining interest rate environment, these funds, along with gilt funds, are to benefit the most from rate cuts.
We have also written a blog on Why should investors consider long duration debt mutual funds in 2024.
Gilt funds are debt mutual funds that invest in G-sec bonds with maturities of 10, 20, or 40 years. This category can yield returns greater than 7% annually.
Government Securities:
Government securities are among the most secure debt instruments, as they are backed by the government of India. These securities are issued for the long term to raise funds for purposes like infrastructure development, financial budget deficits, etc.
Government securities are a promising investment avenue if you want to hold your money for a longer tenure. GOI Sec 7.10 08/04/2034 means the bond is yielding 7.10% interest with a maturity of 10 years in April 2034.
Taxation on interest earned is added to Income from other sources and taxed as per the investor’s tax slab. Appreciation in bond prices is considered Capital gains, and LTCG at 12.5% is charged at the time of maturity.
NPS:
National Pension Scheme is a long-term retirement-focused investment product that invests in multiple asset classes, such as equity, bonds, g-secs, etc.
NPS are divided into two categories: Tier I and Tier II. Tier-I accounts have a 60-year lock-in period until maturity, while Tier-II accounts are more like savings accounts, with flexible deposit and withdrawal options.
NPS has given consistent returns of 8% to 12% in the last ten years since its inception. New investments made after April 1, 2023, are taxed as per the income tax slab rate of the investor.
PPF:
PPF, or Public Provident Fund, is a famous investment option that offers guaranteed fixed returns annually. It is one of the most popular investment options in India and comes with a 15-year lock-in.
Investments made in PPF are eligible for a tax deduction of Rs. 1.5 lakh per annum. It comes under the EEE (Exempt-Exempt-Exempt) category, which means that if held until maturity, the interest amount and maturity proceeds are completely tax exempt. This makes it an ideal alternative to fixed deposit investments for long-term investors.
The current PPF interest rate is 7.1% (Q2 of FY 2024-25)
Physical Gold:
For centuries, Gold has been the safest and most reliable investment choice in India. Out of the total Indian wealth, more than 15% of investments in physical Gold are in the form of coins, bars, or jewelry.
In the short term, Gold might be volatile or flat, but over the long term of 10 and 15 years, It has given annual returns of 10.7% and 11.9%. Gold’s returns are nearly double the average rate of inflation. Gold investments are highly liquid in nature, and now there are many ways to invest in Gold, such as Digital Gold, Gold Mutual Funds, Sovereign Gold Bonds, and Gold ETFs. When held for more than 24 months, Gold is subject to LTCG, and taxation is charged @ 12.5% p.a. If you wish to invest in a long-term fixed deposit, Gold can be a better alternative, with higher returns and lower taxation.
Conclusion
In conclusion, while fixed deposits appear safe and secure, they often struggle to keep up with inflation and are subject to high taxes. Company fixed deposits may offer higher interest than bank deposits, but they come with added risk.
Additionally, fixed deposits are not very liquid, making it harder to access your money. Investors might want to consider debt mutual funds with lower exposure to domestic equity, as they offer better returns, higher liquidity, and more favourable tax benefits.
If you want to diversify your portfolio, you can opt for any of the alternative to fixed deposits, as mentioned above. Understand the benefits and drawbacks of each option and align it with your goals and investment horizon. Make sure to consult your financial advisor before investing in them.
