Talk about interest rates going up has picked up pace after the Reserve Bank of India (RBI) raised key policy rates last week. For most of us, it is almost a non-event — unless you have a floating rate housing loan — as a quarter percentage increase in fixed deposits (FDs) does not make many people rush to the dance floor.
However, there is another large group, which keenly follows the trends in interest rates — people whose idea about investing and savings end with bank FDs and company FDs. Due to spiralling living expenses, this class of investors has started taking a hard look at company deposits lately, say financial advisors. Company FDs have seen a renewed interest and higher flows from investors in the past one month, they say.
Investors preferring company FDs
To start with, inflation is in the double-digit territory and bank FDs are, at best, fetching merely 7-8% interest per annum. So, the real return from bank deposits is negative, which has led to lot of people making a beeline for company FDs that offer a slightly higher return than bank FDs.
Secondly, over the past one-and-a-half year, the Sensex has moved from 8000 to 19000 – 20000 range, an unexpected windfall for many investors, making them a bit nervous about the future course of the market in the process. This has prompted some investors to book profits and invest the money in safe and simple products like company FDs. Finally, interest rates have hardened by around 1% over the past one month, which has also attracted new investors to these deposits
Company FDs provide higher interest rate
Over the last one month, we have seen an increased flow in company fixed deposits due to higher interest rates.
We have seen some equity investors book profits and allocate money to debt products such as company fixed deposits in the recent past. More than half of Indian savings find their way to bank FDs. Investors looking for higher returns mostly end up chasing company FDs.
On an average, an AA-rated company offers around 2% higher return than a bank fixed deposit. Sure, not a reason to call for a party, but even an extra percentage or two count a lot when you are living on interest income — as most retired people do in our country.
Beware of dubious players
However, the problem with company FDs is the presence of dubious players who enter the market time and again. There are companies, mostly on the verge of shutting down, that enter the market with the promise of extremely higher returns. Often some people tend to overlook the rating assigned to these companies (which are invariably low) and end up being cheated by the company at the time of repayment.
However, that does not mean you should not check the company deposit space. Indeed, you should. But stick to certain rules which you should never break in search of better returns. These rules are simple, but they have stood the test of time.
Can you part with the money?
Before investing in a company deposit, you should ask yourself whether you can actually part with the money for the term you have chosen for the deposit. This is because, compared with mutual funds or bank FDs, company FDs are not very liquid instruments.
In most cases, premature withdrawal is not allowed before three months. If you wish to withdraw between the third and sixth month, you may not get any interest at all. If you are forced to withdraw the money between six months and a year, you get 3% less than the guaranteed return.
Does the name ring a bell?
Before investing in a company, check with your financial advisor about the credentials of the company. Bluntly put, ask whether the company has ever duped investors in the past. In case of a listed company, you could take a look at the financial results before making an investment decision. But why do this exercise? Sure, you don't do any of these things while putting money in a bank FD. That is because those deposits are covered by a Deposit Insurance and Credit Guarantee Corporation of India guarantee, which assures repayment of Rs 1 lakh in case of a default.
However, company deposits offer no such guarantee and the safety of the FD depends on the company's financial position. That is why you should opt for companies that pay dividends and are profit-making. Another starting point could be the rating enjoyed by the company. Financial experts say investors should go only for triple-A or double-A rated schemes.
Know the risk
Just like the stock market, the company deposit space is also inhabited by a variety of species. Depending on their reputation, the interest rate offered by them can vary. For example, a veteran player in the market like HDFC will offer you only 7.75% p.a. for a three-year fixed deposit, but a relatively-unknown recent entrant in the deposit market like Ankur Drugs offers 12%, while Asian Electronics offers 10% p.a.
Why do these company FDs offer you higher returns? Because these deposits are a little riskier than the state-sponsored small saving schemes or mutual fund schemes which invest in a debt portfolio. Here, the only factor that could assure you timely payment of interest as well as repayment is the company's financial strength. So, the company with a stronger financial record will pay less and the emaciated ones will be forced to offer a little extra.
How much should you invest?
Just because some companies offer better interest than banks, you shouldn't rush to invest your entire corpus in company FDs. Never forget the principle of diversification even when it comes to the debt market — never put all your eggs in a single basket.
Based on your risk profile, you could invest up to 10% of your investment in company fixed deposits. He also warns investors against putting the entire money in a single company. It makes sense to diversify by spreading your deposits across a number of companies and industries to reduce risk.
Some strategies for you
Some companies like HDFC also offer you a monthly income plan (MIP) wherein you can draw your interest on a monthly basis to help meet your expenses. They also offer a SIP where you can invest every month instead of a lump sum to build a bigger corpus. Based on your risk profile, you could invest up to 10% of your investment in company fixed deposits.
Investors should not put all your money in a single company. It makes sense to diversify here by spreading your deposit across a number of companies and industries to reduce risk. Unless you need a regular income, you could select from a range of cumulative schemes to regular income options since the interest earned automatically gets reinvested at the same coupon rate, giving you higher yields in the process.
Company Deposits vs Bank FDs
High inflation is eating into the real rate of return from FDs, forcing many investors to opt for company deposits
Typically, an AA-rated company offers around 2% higher interest than a bank FD
Always opt for an AA or AAA-rated company, as companies rated below could be risky
However, company deposits are not as safe as bank FDs, as there is not guarantee on capital repayment
Check the past record of the company, as the safety of your money depends on the financial strength of the company
Spread your money across a number of companies to make sure your entire corpus is not affected by a default by any company
