RBI maintains status quo

As against everybodya's expectation, RBI has maintained status quo and left repo rate and CRR unchanged.  Inflation weighed on RBI's monetary policy decision and RBI's press release stated that it "had frontloaded the policy rate reduction in April with a cut of 50 basis points."

Thus no significant change in interest rates offered on fixed deposits by banks is expected anytime soon.  Bachhat updated its page on FD interest rates on 15th June 2012.  Next update shall be around 15th July 2012, unless RBI acts on the rates between two monetary policies.

Interest rates on fixed deposits (Updated as of 15th June 2012)

Before RBI takes any action during its monetary policy review schedule on 18th June 2012, we thought of updating interest rates on fixed deposits offered by various banks.

Looking at the slowdown in growth rates and developments in Europe,  it is widely expected that RBI shall cut either cash reserve ratio or rates.  However, after WPI inflation of 7.55% in May 2012 and upward revision of March 2012 inflation to 7.69%, analysts are not sure whether the rate cut shall be 25 basis points or 50 basis points.  100 basis points equals one percentage point.

The coming week will answer all the queries and Bachhat shall revise the interest rates details shortly thereafter if bank changes their interest rate offerings.

Click here for latest interest rates on fixed deposits

Ultra short term debt funds - Pepping up your post tax returns

Sanjay was busy on the phone since last five minutes.  Sanjana sat across the table at a neighbourhood coffee day shop where both of them agreed to meet in the evening.  Finally, when Sanjay disconnected his phone, Sanjana asked him whom he was speaking for so long? 

Sanjay saw the curious eyes of Sanjana and offering a smile said, “My relationship manager from XYZ Bank.  She was offering me advice on managing my money.”

“Oh good.  So now you are a special customer of your bank and have a dedicated relationship manager?” quizzed Sanjana.

“Yeah.  I became their special customer since I started maintaining an average balance of Rs. 2,00,000 in my savings bank account and fixed deposits.  And I shall continue to be, till the time the average balance is maintained.” answered visibly delighted Sanjay.

“So to have a privilege of relationship manager, you maintain a balance of Rs. 2,00,000 in your bank account!! You are happy to forgo the return on your money for this privilege?” questioned Sanjana.

Sanjay was quick to reply, “No, who says I am not earning return.  My savings account gives me 4% and bulk of the money is in fixed deposits, which earns me anywhere between 7% to 10% per annum.  You see my money has been effectively employed for providing returns plus special customer benefits.”

“The returns you are mentioning are absolute returns.  Have you ever thought about post tax returns?  If I am not wrong you are in 20% tax rate bracket, right?” to which Sanjay nodded.  Sanjana continued, “Even if I consider the fixed deposit giving you 10% per annum return, 20% tax would leave you with post tax return of 8%!!”

A visibly annoyed Sanjay said, “Well that’s the best return I can get for liquidity and low risk.  You only told me other day that one needs to compromise the return if he is not willing to take risk and wants liquidity.”

“That’s true” said Sanjana pleased by the fact that Sanjay still remembers what she had told him few months back when they had discussion on the risk and return trade off. “Savings accounts / fixed deposits are the best place for high liquidity and minimal risk returns.    However, why to maintain a huge balance in your savings account when there are other low risk, high liquidity alternatives available providing better returns?”

Confused Sanjay said, “I do not understand what you are saying.  Can you please elaborate?”

“Sure” Sanjana replied, “See, I am not against maintaining adequate money in savings / fixed deposits.  This is required for any unforeseen immediate requirements.  However, one can pep up the returns by investing excess portion of the money lying in savings account in debt funds which provides liquidity along with low risk and high returns.”

Suspecting no response from Sanjay, Sanjana continued. “I am referring to ultra short term debt funds offered by mutual fund companies.  These funds provide tax-efficient returns with liquidity and low risk.  I agree that these funds are not as safe as fixed deposits, but given the low maturity profile of these funds the risk of losing money is minimal.”

“Tell me more about them and especially tax-efficient returns that you mentioned” stated Sanjay eager to learn from her friend.

“These funds, earlier known as liquid plus funds, invest in short term debt papers which have maturity of more than 90 days but less than 1 year.  Barring few, they do not have any entry or exit loads and one can redeem it any time with proceeds credited to bank account by next day or at the max, day after depending on the timing of your redemption.”

“Since these funds invest in debt instruments and commercial papers of corporates, their returns are attractive even after deducting fund management expenses.  In last 12 months, good ultra short term funds managed to provide returns anywhere in excess of 10% to 9%.  However, the most important factor which tilts the pendulum in their favour is their tax treatment.

“Though any gains arising out of such investments are treated as capital gains and taxed at applicable short term or long term capital gains rate, many of these funds provides dividend option and facility to reinvest dividends.  The interesting thing is dividends are taxed at lower rates and thus it boosts post tax returns.

“Let me give you an example.  If you invest in such funds with daily dividend reinvestment option, any increase in NAV during the day is declared as dividend by the fund and gets reinvested after paying dividend distribution tax at 12.5% plus surcharge and education cess.  Since dividend is tax free, it is not taxed in the hands of investor.  Since all the gain is declared as dividend, NAV of the funds remains unchanged and there are no / insignificant capital gains tax at the time of redemption of units.” 

  

Trying to put things together, Sanjay said, “So you mean to say there is only dividend income on which fund pays the tax @ 12.5% and dividend is tax free for me.  Since this tax rate is less than the tax @ 20% which I pay on interest income from fixed deposits, even if the fund earns 10%, my post tax returns are better than post tax returns on fixed deposits.  And if one falls in highest tax slab of 30%, it is more beneficial, right?”

Also see – Mutual Fund Tax Reckoner

“Absolutely,” said a happy Sanjana realizing how easy it is to explain to Sanjay, "Tax benefit varies according to one's tax slab.  For persons paying 30% tax, the benefit is the highest."

“But if they are tax efficient, why just ultra short term debt funds which invests in debt papers with maturity of more than 90 days.  I can also invest in funds which invest in debt papers with maturity of less than 90 days.  I am sure there must be such funds in the market.” It was now Sanjay’s turn to question Sanjana.

“Correct.  There are funds which invest in debt papers with maturity of less than 90 days – those are call liquid funds.  However, they are not tax efficient, since dividend distribution tax on dividend distributed is 25% plus surcharge and education cess.  Thus on post tax return basis, they are at disadvantage as against ultra short term debt funds.”, Sanjana clarified.

“Okay.  I understood.  Ultra short term debt funds provide high post tax returns if one opts for dividend reinvestment option and they are liquid investments, but slightly riskier than bank fixed deposits.  However one can pep up their returns by investing surplus funds in them.”

“Bingo.”  Sanjana nodded, as Sanjay’s mobile rang again. 

Disconnecting the call,  Sanjay smiled and said, ‘Who now needs a relationship manager if one has such a good friend providing free financial advice!!’ sipping his cappuccino crowned with choclate sauce.

Have you ever invested in Ultra Short Term Debt funds?  Share your views on them with us.

India - the country with least financially literate people??

Visa carried out an interesting survey early 2012 in 28 countries to guage the strength and weaknesses of financial education worldwide.  Five simple questions were asked like 

• Do you have and follow a household budget?, 
• How many months worth of savings do you have set aside for an emergency?, 
• How often do you talk to your children ages 5 - 17 about money management issues?, 
• To what extent would you say that teenagers and young adults in your country understand money management basics and are adequately prepared to manage their own money? and
• At what age do you think Govt. should require schools to teach financial literacy to children, so that they can better understand money management issues?

It was surprising to see that out of 28 countries surveyed, India stood 23rd, country with one of the least financially literate people.  Per the findings of the survey, only 35% of its population was termed financial literate.

Average savings set aside by Indians for an emergency is approx 1.9 months.  In addition, 41% of the younger respondents aged 18-24 were more likely to have no emergency savings at all compared to older respondents.

Families generally do not talk to their children about money and finance.  Indian families spends only 10 days a year as compared to global average of 19 days / year with their children discussing money issues.

43% of women said they do not understand personal money management issues.

This may sound surprising to many of us, but be practical and ask the above questions to yourself.  

When was the last time you made your household budget and followed it?  Do you even have emergency fund?  Do you know who much amount is available in emergency fund or ideally required?

One may argue that even though I do not do / know the above, I spend my finances rationally and am overall informed about by financial condition.  It is true that above questions alone can not determine whether you are financial literate or not, however it is also true that having a budget and keeping track of it, etc are the preliminary steps one needs to carry out in financial planning.

Are you amongst the one who does not keep track of your finances or do not know about emergency funds?

Source: 

1. Visa's http://www.practicalmoneyskills.com/resources/barometer.php

2. First post's news article