Mar 27, 2010

Where to park your money required after one year?


I am planning to purchase a house very soon but that time duration could go to a year or more, in the meanwhile I have around 10L laying in my saving account. Any advice .to use it wisely, I have already invested in generally most of fund like PPF, Bonds, FD, ELSS etc.__Vinod


There are plenty of options available for parking your surplus funds depending upon the duration for which you can spare your money. Here the discussion is limited to investment of surplus funds when the time horizon is one year plus, say, around 13-14months.

Your first option is to stay invested in the savings account where you’ll get an interest rate of 3.5% p.a.

If absolute safety of your capital is important to you, then the other safe option is
fixed deposits (FDs) of banks which are currently offering interest rate of around 6.5% for one year.

If you’re looking for higher post-tax returns, then you should consider investing in Fixed Maturity Plans of mutual funds. The major difference between FMPs and other debt funds is that due to holding of instruments till maturity FMPs are least exposed to interest rate risk. Further, FMPs floated in last quarter of a financial year with duration of 13-14 months offer the benefit of double indexation which makes them even more tax efficient.

Let me explain how does it work—as you know that mutual fund debt schemes are tax efficient as compared to bank saving and fixed deposits. While interest from FDs and savings account is taxable at your marginal tax rate (MTR), the gains from debt funds are taxed in the form of dividend distribution tax (DDT) if dividend option is chosen and / or Capital gains in case of growth option. Further, capital gains from mutual funds are of two types: short term (up to one year) and long term (more than one year). While short term capital gains (STCGs) are taxed at the marginal tax rate, long term capital gains are taxed either at the rate of ten per cent without indexation or 20% with indexation.

Further, when you invest at the end of financial year in an FMP which will mature just after the end of the next financial year, you get entitled for double indexation benefit making your capital gains virtually tax free. For example, if you invest in an FMP in March 2010 and it matures in April 2011, your investment gets spread over three financial years and you get entitled for indexation for 2 years i.e., FY 2010-11 and 2011-12.

At the end of the year even if FMPs deliver return equivalent to one year bank FDs, your post-tax yield will be considerably higher than that of a FD. Assuming tax on FMP to be virtually ‘nil’ after considering double indexation benefit, the post yield of FMP will be same as pre-tax yield i.e., 6.5 per cent as against post-tax returns of 5.16% and 4.49% from bank FD for an individual in the middle tax bracket and highest tax bracket respectively.

However, although FMPs are now listed on the stock exchange, trading volumes are low and therefore exit is difficult and might have to exist at a discount to the NAV, so invest if you can remain invested till the date of maturity.

In short, for an individual in the middle or highest tax bracket with a time horizon of slightly more than a year and that too at the end of a financial year, there’s nothing to beat FMPs with better returns which are tax efficient and carry negligible interest rate risk and low credit risk.

On the other hand, for an individual with zero taxable income or in the lowest tax bracket of 10%, it will be better to invest in bank FDs instead of FMPs because the marginally higher returns, if any, from FMPs will not matter much due to credit risk involved (although low) and poor liquidity.


P.S. Today is March 27, 2010; you still have 4 days left to invest in FMPs and avail double indexation benefit.


Also Read:

1. Is it worth investing in KVPs?
2.
5 things to avoid while investing in equity diversified funds
3.
What is the right time to buy a home?
4.
Mutual Fund Tax Benefits

6 comments:

  1. I had also somewhat same situation in Jan. where I've to save bucks for 1-1.5 yrs horizon. say 30k per month. I opted for RD @ 6.25% for 15k per month and remaining 15k pm are going to HDFC floating rate long term fund (18 months).

    Do you think this strategy as good one or any other idea?

    Thanks,
    Jagbir Singh

    ReplyDelete
  2. Long term capital gains are taxed either at the rate of ten per cent without indexation or 20% with indexation. How does an investor know which amount is better - ten per cent without indexation or 20% with indexation?

    I was told that MF redemptions do not have a TDS for Resident Indians. Do we have to declare this separately then?

    ReplyDelete
  3. Hi,

    My case is similar, i have around 6 lacks to invest for 2 to 3 years,
    What are the best schemes in Mutual fund's and any other debt instrument.
    I Plan to make around 2.5 Lakh as profit in these two years.


    Raj

    ReplyDelete
  4. Jagbir,

    HDFC Floating Rate Long Term is a high credit quality fund with low interest rate sensitivity and good returns. As on date, average 3-yr CAGR is around 6.6%. The major concern is the high exit-load of 3% if units are redeemed / switch out with in 18 months from the date of allotment.

    Your post tax returns would depend upon your tax bracket and option (dividend / growth) chosen while investing in the HDFC floater.


    Pradeep,

    It depends on case- to- case basis and only way to know is by calculating it separately for each individual case.

    Yes, there is no tax deduction at source from mutual fund units in case of resident individuals. Non applicability of TDS doesn’t mean that income is exempt and therefore, the same is to be disclosed while filing return of income.


    Raj,

    You expect to earn Rs 2.5 lakh in 3 years time by investing a sum of Rs 6 lakh. In other words, your return expectation is around 12.30% per annum.

    Sorry, instead of debt funds you should consider equity diversified funds and be prepared to bear the associated risk.

    ReplyDelete
  5. AnonymousMay 10, 2010

    Hi,

    I have been following your blog recently and i am pretty impressed with the quality and insight of information given in the articles.

    Further, with reference to the above artcile, i have some spare (13-14 months) money (1.5Lacs) in my savings bank a/c on which i want to earn a little more (other than the F.D. option) than the savings bank interest @ 3.5%. I finalised investing the money in a short term bond fund (Templeton India s/t gr fund) for 13-14 months.

    What is the difference b/w a short term bond fund and a FMP (as mentioned in the above article)? Which is a better option?

    Thanks,
    Shekhar

    ReplyDelete

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