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Saving for the rainy day? Top 5 savings plans

Last updated on: May 11, 2010 19:19 IST

Saving for the rainy day? Top 5 savings plans

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Interest rates are rising. It is good news for some - those who look at making deposits; bad news for some -- those who are looking at taking loans.

Savings, however, have to be channelled carefully so that the maximum can be gained from the deposits. Here are the top five savings instruments in a rising interest rate regime.

In today's scenario the top 5 savings instruments are:

1. Debt Mutual Funds.

2. Mutual Fund Monthly Income Plan -- Growth Option.

3. Company Deposits.

4. Post Office Recurring Deposit.

5. Post Office Monthly Income Scheme.

1. Debt mutual funds

These are managed funds that invest the funds from the investors predominantly in debt and debt oriented schemes.

There are a number of advantages that these mutual funds give compared to a direct deposit. The most apparent is the fact that this is a managed fund and the returns can be better as the manager has access to more information and will leverage that compared to individual investors. There is no TDS or tax on the interest. The returns will be processed as capital gains.

Returns from this fund are expected to be good. The top five debt mutual funds have given compounded returns in the range of 10.50-14.50% in the last 3 years.

This is much better than the normal bank deposit or company deposit. The advantage is that debt mutual funds can create capital gains when the interest rates go down.

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2. Mutual Fund Monthly Income Plan: Growth Option

For people who have a higher risk quoitent during the short term, monthly income plan (MIP) of mutual funds is good. Here a small portion (generally not more than 20%) of the funds is invested in equity.

So the returns can be better than the normal debt mutual fund when the market is rising. The typical returns in the last three years are 12% to 14% for the top 5 funds.

However caution needs to be taken when choosing the growth option. This is due to the fact that if we start to receive the monthly payouts there may be months when the principal is used for the payout. This will drain the fund particularly when the market goes down.

Being largely a debt oriented mutual fund, the tax treatment is the same as the debt mutual fund.

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3. Company deposits

Companies that offer deposit schemes to consumers tend to offer rates that are in-between bank deposit rates and bank lending rates. This is a win-win situation for the company and the person saving.

The bank has to make a profit when borrowing from the public and lending to companies. So they have an interest rate difference (spread) of about 4.5%.

In effect, the deposit holders are paid less and the borrowers are charged more. When a company has direct access to the depositor, both benefit.

The depositor gets a better rate than what the bank can offer and the company is able to borrow at a lesser rate when compared to a bank interest rate.

However, it is in the best interest of the borrower to do his research thoroughly and double check how good the credit rating of the company is before investing. On an average estimates show that one can easily get 11-12% on reputed companies' deposits for a 3 year term.

The returns will be taxed as interest and will have TDS.

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4. Post Office recurring deposit

This is a five-year scheme where one invests on a monthly basis. However, there does exist an option for the fund to be closed after 3 years, which comes with a penalty of 1%.

The advantage with the postal recurring deposit over the bank recurring deposit is that the minimum monthly investment is only Rs 10 with no upper limit. In case the payment is made once is 6 months or on a yearly basis, there are discounts for that too.

The limitation is that the interest rate is fixed at 7.5% only and auto-debit to bank account is not available.

There are no tax benefits from the scheme. However Post Offices have not been deducting TDS.

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5. Post Office Monthly Income Scheme

For the retired people, the Post Office Monthly Income Scheme is a good savings instrument. The interest is 8% divided on a monthly payout basis. The payout if not required can be channeled to a recurring deposit. The effective returns increases by almost 10% by doing this.

The interest can be credited to a savings account of any bank too. The account can be closed after 1 year with a 5% penalty and after 3 years without any penalty. The limitation however is that the maximum investment for any individual is only Rs 600,000.

The ranking of the above five savings schemes have been done based on their returns, the convenience factor to close and change to another savings scheme (important when the interest rate is rising) and the safety for investments.

Of all the options the debt mutual funds appear to score the highest due to their flexibility and returns. This is closely followed by the mutual fund MIPs.

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Rate of Return (Typical)

Lock in period

Instrument Performance in terms of returns for the past 1 year

Instrument Performance in terms of returns for the past 3 yrs

Tax implications

Debt Mutual Funds

8.75 - 10.15%

No lock-in period

6.80 - 10.20%

10.75 - 13.75%

No tax on the interest. Capital gains applicable at 20% within one year and 10% for more than 1 year holding period.

Mutual Fund Monthly Income Plan Growth Option

11.75 - 14%

No lock in period. Exit load of 1% exist in some companies if withdrawn within one year.

17.50 23.80%

12.20 - 14.45%

No tax on the interest. Capital gains applicable at 20% within one year and 10% for more than 1 year holding period.

Company Deposits

10%

Minimum 1 year

10% to 11%

10% - 12%

No Income Tax deducted at source if interest income is up to Rs 5,000

Post Office Recurring Deposit

8%

5 Years. Minimum 3 years with penalty of 1%

8%

8%

No Tax Benefit. Income earned is added to income from other sources and calculated according to the tax bracket of the individual.

Post Office Monthly Income Scheme

8%

(10% effective interest if the monthly payout is reinvested in the recurring deposit)

6 years.

Minimum 3 Years with penalty of 5%

8%

8%

No Tax Benefit. Income earned is added to income from other sources and calculated according to the tax bracket of the individual.



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