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The safest investment plans
Tejas P Bhope, Outlook Money
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July 26, 2006

Debt instruments protect your capital, therefore the importance of a solid debt portfolio. This not only gives stability, but also offers you optimal returns, liquidity and tax benefits. A common mistake while making an asset allocation is to overlook the contributions made to provident fund, insurance endowment plans and public provident fund.

These investments are also in the debt part of a portfolio, making it debt heavy. So do keep that in mind before you look at our shopping list below.

Short-term options

Good for short-term goals, you can look at liquid funds, floating rate funds and short-term bank deposits as options for this category of investment. Liquid funds have returned around 5 per cent post-tax returns as compared to 5.6 per cent post-tax that your one-year 8 per cent bank fixed deposit gives you.

So, if you have funds for investment for over a period of one year, it is better to go in for bank deposits. However, liquid funds are better, if your time horizon is less than one year - say around six months.

This is because the bank deposit rates decrease proportionately with lower periods, while liquid funds will yield the same annualised return for any period of time. Short-term floating rate funds can be considered at par to liquid funds for short-term investments.

Fixed Maturity Plan

If you know exactly for how much time you need to invest your surplus, a smarter option is to invest in FMPs. They are shorter-tenured debt schemes that buy and hold securities till maturity, thereby eliminating the interest rate risk. Try and opt for FMPs that offer a double indexation benefit (See table: Double Indexation).

Fund houses usually launch double-indexation FMPs during the end of the financial year so that they cover two financial year closings.

Not to worry though if the end of the year is far away. Fund houses launch FMPs throughout the year that yield attractive returns. You could ask your mutual funds agent to keep you posted when such FMPs tap the market.

Other options are FMP-plus schemes like Franklin Templeton Fixed Tenure Fund or HDFC [Get Quote] Multiple Yield Fund that come with a small equity flavour. These work on the same principle but invest only about 70 to 85 per cent in debt and the rest in equities.

So while the debt component is held till maturity and accumulates to reach the original investment, the returns kicker comes from active equity management. Launched in April 2005, one such scheme - FTFTF has returned 16 per cent since inception.

Medium & long-term options

These options typically offer low or virtually no liquidity. They are, however, largely useful as income accumulation tools because of the assured interest rates they offer.

These instruments should find place in your long-term debt portfolio. Like Sandesh Kirkire, CEO, Kotak MF says, "Small savings is a subsidy from the government because the rates are higher than the market rates. Take it while it is still on offer."

Employee Provident Fund: PF will also be counted as your debt component, which can be maximised to 20 per cent of your basic salary, the company contributes another 12 per cent. This contribution will yield a return of 8 per cent and will be eligible for tax benefits under Section 80C.

Public Provident Fund: You simply can't miss out on this one. It offers a return of 8 per cent per annum, lasts for 15 years and is still EEE or exempt at all stages from tax.

However, it doesn't score too well on liquidity. PPF is a great investment if you have age on your side so that you can maximise the benefit by extending the period of holding.

National Savings Certificate: NSC is another attractive instrument offering a return of 8 per cent. While the interest component gets accrued (deemed to be reinvested), it is returned to you along with the principal only on maturity.

Although NSC has a relatively lower tenure of six years, liquidity is one area where it scores poorly. An added incentive is that the accrued investment is automatically reinvested, and also qualifies for benefits under Section 80C.

Kisan Vikas Patra: The scheme runs through a tenure of eight years and seven months, over which the money doubles. Liquidity in KVP is available any time after 2.6 years from the investment date, but a loss of interest has to be borne on premature liquidation.

Investments in KVP don't qualify for tax benefits and the interest earned is also fully taxable as per your tax slab rate. Invest in KVP, if you have some spare cash after investing in tax-saving instruments.

Post Office Time and Recurring Deposits: Available for periods ranging from 1 to 5 years and with the interest rates ranging from 6.25 to 7.5 per cent, these are good for liquidity. You can exit a POTD within six months of starting one without receiving any interest and if withdrawn after one year then 2 percentage points are deducted. But there are no tax benefits in either of the schemes.

Bank Deposits: These are flexible, liquid and offer good interest rates today. Make use of the two-in-one savings accounts that banks offer (surplus over a specified sum is transferred to a deposit) to get a higher return on the money accumulating in your savings account.

In the recent Budget, the benefit of Section 80 C was also extended to bank deposits, which are kept with scheduled banks for a minimum period of five years. The notification for this is yet to come.

Post Office Monthly Income Scheme: As the name suggests, this scheme provides a monthly income at an interest rate of 8 per cent. It has a maturity period of six years. This instrument has become less attractive after the 10 per cent maturity bonus and the Section 80L tax benefit were taken away. Best suited for retirees who are looking for regular and assured returns.

Senior Citizens Savings Scheme: You can buy if above 60 years of age or above 55 years and voluntarily retired. The upper limit for investment is Rs 15 lakh (Rs 1.5 million). SCS offers a return of 9 per cent, making it a compelling proposition for the senior citizen. The tenure is five years and can be extended by another three years. Liquidity is available after one year but it proves costly, as there is a penalty of 1.5 per cent of the amount deposited. No tax break and now you need to pay TDS too.

What you should do

First, make full use of PF and PPF for your tax-saving investments. If you don't have liquidity needs and a further surplus, then you can maximise your investment in PPF and NSC.

Extras can go to KVP and POMIS. If you are a senior citizen, and are looking for regular income, then the combination of the Senior Citizens Savings Scheme and Post Office Monthly Income Scheme will do the trick for you.

If you invest the maximum possible amount in these two instruments, you will end up earning almost Rs 13,250 per month before tax.

You can also design other strategies by combining products like POMIS and Post Office Recurring Deposits. The former offers 8 per cent returns in a monthly payout, which can then be reinvested in a 7.5 per cent recurring deposit.

So, the effective yield would be 9.33 per cent. Once your debt portfolio has been maximised, you can look towards the higher risk products to get higher returns.

Short-Term Options: Liquid Returns


 Returns %

NAV (Rs)

3 Months1

6 months1

Exp ratio2

Liquid funds






LIC [Get Quote] MF Liquid





UTI Money Market





Short-term floating rate funds






LIC MF Floating Rate-ST





Principal Floating Rate-SMP





1As on 23 June '06, absolute returns 2Expense ratios as per May-end portfolios.
Schemes directed at retail investors with three and six months' rolling returns.

Double Indexation Kick

One-Year Plus Fixed Maturity Plan (FMP)

How double indexation works

Net yield pre-tax


Amount Invested




Maturity Date


Maturity Value


Double Indexation Calculation

Assumed Inflation rate


Amount Invested


Indexed value at end of Year 1


Indexed value at end of Year 2


Capital Gains Tax Calculation

Maturity Value [A]


Indexed Cost [B]


Taxable Capital Gain [A-B]


Capital Gains Tax


Post tax maturity value


Post Tax yield


Assume the FMP yields 5.80%. Your initial investment of Rs 100 grows to Rs 106.67. But due to rising inflation every year, your cost of purchase (Rs 100 in Year 1) is worth much more as time progresses. However, the fund's tenure is such that it passes through two year-ends, thereby earning the benefits of indexation, twice. Cost of purchase (Rs 100), therefore, rises to 110.25, assuming a 5% annual inflation rate taken into account twice. Therefore, the higher cost of purchase negates any capital gains, and the capital gains tax.

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