Recurring Deposit can help meet near-term goals

Have you ever felt an irresistible desire to go for an overseas vacation or give a precious gift to your loved one, but have been stopped in your tracks by the lack of funds?

Many a time, we let go of our aspirations because it seems difficult to achieve them at one go.

Often, people lose sight of small but important means to reach their goals when the goal appears to be too large.

Surinder Chawla, head, Retail Liabilities Product Group, HDFC Bank, said: "We all have to move towards regular savings because a lump sum is not available when we want it.

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"Clearly, if we have to realise our short-to-mid-term goal in a systematic and risk-free manner and also get a reasonable rate of return, the discipline of developing a regular saving habit is very important."

Small and regular saving instruments, such as a recurring deposit, can help you achieve your near-term financial goals without too much pain.

All you need is some early planning and a saving discipline. Consider, for example, Noopur Sharma, a private sector bank employee, who wanted to gift a digital camera to her brother on his birthday.

She started a year in advance, with a Rs. 1,000 monthly RD and was able to gift her brother a camera just before his next birthday.

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Manish Jain, a Gurgaon-based financial planner, said: "It's vital to have regular savings for realising your mid- and short-term goals. Since the time horizon is near and the safety of the capital is crucial, small but regular savings can help attain the goals."

Why RD?

Remember, slow and steady wins the race. Suppose you wish to buy a house for Rs. 50 lakh and have a timeline of five years.

You may start with a monthly saving of Rs. 13,720 and you would have accumulated Rs. 10 lakh at 7.5 per cent a year interest during this period, taking care of the down payment (see Timing it Right).

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With interest rates peaking, any investment in RDs would fetch you good returns.

While the interest rate on a post office recurring deposit is stagnant-around 7.5 per cent-many banks are offering rates ranging between 8 per cent and 9 per cent for RDs with a maturity of 1-5 years.

An RD stands out as an option for achieving short-to-mid-term goals.

Jain said: "Equity or equity-based investments are suitable when you have a time-horizon of five years or more. For less than five years, one should use a mix of equity and debt (fixed income); depending on one's risk appetite. The nearer the financial goal, the more skewed your investment should be towards debt.

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"If your investment horizon is one year or less, there should not be any equity element in your portfolio."

The tax story

Unlike fixed deposits, where banks deduct TDS (tax deducted on source) on the interest earned, there is no such deduction in the case of an RD.

The tax liability rests with the depositor on his overall annual income through all sources.

But as Jain says: "The biggest drawback of an RD is that if you are in a higher tax bracket, the post-tax returns won't be able to beat inflation."

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For example, if you are in the 30 per cent tax bracket and are investing in a post office RD, your real returns could be negligible, or even negative, after accounting for inflation.

So, if you don't fall under the highest tax bracket (30 per cent for an annual income above Rs. 8 lakh) and have short-to-mid term goals to be realised within five years, an RD is an attractive proposition.

Also, RD is the way to go for the risk-averse. This is because you would know how much to invest and what you would get on maturity.

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But it is considered a rigid product as banks insist on timely payment of installments, failing which you need to pay a penalty, which may vary from bank to bank.

So, before you decide on how much you want to invest in an RD, do a proper analysis of your income and expenditure.

If you have any surplus over and above that, you may invest it in other avenues.

Timing It Right

Identify your requirement and the time horizon.

Suppose, you plan to buy a car in the price range of Rs. 5 lakh-7 lakh three years down the line.

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In that case, you need to accumulate a down payment amount of Rs. 2 lakh.

This you can do by opening a recurring deposit with Rs. 4,914 as monthly deposit. Here's how this instrument can help you achieve various goals.

Need money midway?

If you are in an urgent need of money midway, banks allow premature withdrawal of the RD.

However, you might lose out on the interest by 1-1.5 per cent.

A better option would be to take a loan or an overdraft against the balance of your RD.

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While Canara Bank offers loan against the RD balance, State Bank of India, gives both loan and overdraft against a recurring deposit, which could be up to 90 per cent of the RD balance.

It's a win-win option for you as, first, your RD keeps earning interest at the original rate and, second, you get a loan or an overdraft at a lower rate compared to other options, such as a personal loan.

Plan early to avoid credit.

If you use credit cards to meet unplanned expenses, you end up paying around 40 per cent interest a year if you pay the minimum amount due each month.

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Brijesh Dalmia, a Kolkata-based financial planner said: "If it (credit card outstanding) is not carried forward, no interest is charged. I don't mind using a credit card for very short-duration purchases.

"But using the credit card for various expenses and paying interest on them is a strict 'no'. Plan early and save money in your savings account or through an RD or a liquid MF."

The alternate way

For people with fluctuating income patterns, an RD may not be the ideal product.

Dalmia said: "Under an RD, there is a commitment every month to save money even if your budget doesn't allow you.

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"There are other options where you don't have to commit yourself to a monthly deposit, say, a mutual fund, bank FD, and so on.

"In an RD, if you miss a payment, you have to pay a penalty."

If you have an irregular income pattern, you may take a look at the bank sweep-out account, under which whenever you have surpluses above a prescribed level, the bank automatically books an FD of the surplus amount.

There are other saving options as well, such as the systematic investment plan from mutual funds, which might generate better returns, but come with a certain amount of equity risk, or are subject to debt market fluctuations.

Chawla said: "The choice depends upon the risk profile. Factors, such as age or other asset allocation, determine the ratio of RDs and SIPs in your portfolio."