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Three Mistakes Transitioning Fixed Deposit Investors Must Avoid

It rings true that inflation has been controlled in the corresponding period, resulting in positive real returns for even fixed deposit investors. But the fact remains that investors look at their nominal, not inflation-adjusted returns

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We Indian’s love Fixed Deposits. A 2 Lakh+ household SEBI survey released earlier this year only stood to confirm this fact – as it turns out, 95 per cent of us prefer the safe haven of the steady returns and capital safety that FD’s have to offer. At 10 per cent, the number of us who head over to the stock exchanges or mutual fund houses with our money bags pales in comparison.

Ardent FD fans have an obvious problem at hand – rates have been dropping precipitously in recent years. The bellwether State Bank of India recently slashed deposit rates on their 2 to 10-year deposits, their most popular maturity, to a low rate of just 6%. Three years back, you could have booked a 3-year FD with the bank at a much higher rate of 8.75%.

It rings true that inflation has been controlled in the corresponding period, resulting in positive real returns for even fixed deposit investors. But the fact remains that investors look at their nominal, not inflation-adjusted returns. Perhaps this is the reason that FD investors are flocking to Mutual Funds in droves; with their promise of higher growth prospects, they have an obvious lure attached to them. But are many transitioning FD investors winding up shooting themselves in the foot? For starters, they need to avoid these three common mistakes.

Equating Debt Funds with Fixed Deposits

Fund   NameCategoryWorst   Year ReturnBest Year Return
SBI Dynamic   Bond FundDynamic   Bond-4.3%   (Jan 24, 2008 - Jan 23, 2009)17.23% (Dec 07, 2015 - Dec 06, 2016)
ICICI   Prudential Long Term GILT FundGILT-8.18   % (Jan 02, 2009 - Jan 04, 2010)39.01% (Jan 03, 2008 - Jan 02, 2009)
DSP   BlackRock Income OpportunitiesCredit   Opportunities4.27%   (Apr 20, 2009 - Apr 20, 2010)11.81% (Mar 04, 2014 - Mar 04, 2015)
*   source: Valueresearch

The fall in FD rates have sparked an increased interest in Debt Oriented Mutual Funds over the past three years. Per AMFI data, retail investors now have 75,420 Crores parked in Debt Oriented Mutual Funds, compared to 33,749 Crores three years ago. In the same period, HNI (High Net Worth Individual) allocation to Debt Funds have risen by 86,000 Crores, to 2.44 trillion. 

While Debt Oriented Mutual Fund are undoubtedly safer than equity oriented ones, FD investors need to understand their associated risks carefully before breaking their deposits and making the switch. Debt Funds are fundamentally different from Fixed Deposits, mainly because they possess “duration risk”, or the possibility of your capital coming down in value if underlying economic interest rates, or bond yields go up. Consider, for instance, the recent performance of SBI Dynamic Bond Fund - a top performing debt mutual fund. When yields rose by 0.27% between October 16th and November 14th this year, investors in this fund witnessed their fund values getting eroded by 0.23%. In fact, the fund has a 3-month return of just 0.08% as on date^. Similarly, “credit risk”, or the risk that one or more bonds in the fund’s underlying portfolio will default, can drag down returns in the short term. 

Investors need to align their choice of debt fund to their risk tolerance. Notice how long duration GILT funds have oscillated wildly, while accrual based income fund NAV’s have traversed a tighter band. It’s wise to understand debt fund dynamic and associated risks before committing moneys, to circumvent rude shocks in the future.

Replacing Fixed Deposits with Equity-Oriented Funds

Balanced   Funds: Safe Haven or Risky Business?
Fund   NameWorst   Year Return
ABSL   Balanced ‘95-45.00%   (Apr 12, 2000 - Apr 12, 2001)
Franklin   India Balanced-41.39%   (Dec 04, 2007 - Dec 03, 2008)
UTI   Balanced-43.97%   (Nov 19, 2007 - Nov 18, 2008)
Source:   Valueresearch

We’re witnessing a dangerous trend these days. Fueled by FOMO (Fear of Missing Out) and buoyed by past returns, FD investors are making a beeline for equity-oriented funds that are high risk in nature. Net inflows into Equity Funds in the month of October 2017 stood at 16,002 Crores, skyrocketing 70% year on year. Balanced Funds, which are essentially equity oriented, witnessed inflows of 5,897 Crores in the same period.

Indeed, this is a treacherous path for FD-transitioning investors to be traversing. Risk profiling forms the very bedrock of a well-structured investment plan; and by throwing caution to the wind and migrating from FD’s to balanced funds or equity oriented funds, these investors are compromising the very foundation of their asset allocations. If the inevitable vicissitudes of the equity markets were to drag their moneys deep into the red, there’s no saying how they would react; the loss-aversion bias would likely kick in sooner than later, leading to booked losses and burned fingers.

Anecdotal evidence suggests that a number of these hapless FD transitioners are being sold the dividend options of these balanced funds as a purported substitute for their FD interest payouts. This is wrong too, as both the quantum and periodicity of dividends from equity-oriented hybrids are highly unpredictable, and can even dry up at a moment’s notice.

Former FD investors should be careful not to skip across asset classes altogether; FD money that was not meant to be risk-capital should not be exposed to the equity markets.

Locking themselves into Insurance Policies instead

There’s a third mistake that some FD investors are making these days – they’re exiting their deposits and locking themselves into traditional “participating” life insurance policies instead. This is evidenced by the latest data published by the IRDAI, which indicates that Individual Single Premiums mobilized this fiscal up to October 31st, 2017, were nearly 3,000 Crore higher than premiums mobilized in the same period in the previous financial year. Individual Non-Single Premiums have risen nearly 6,000 Crores too.

Befuddled by the opacity of the benefit illustrations of these traditional plans, many FD transitioners are making back-of-the-envelope calculations to justify their decisions to shift into them. However, this is a mistake. If anything, these plans will end up providing them with lower returns than deposits; and with a higher lock-in period and far more restricted access to capital to boot. After all, returns from these plans are linked to underlying bond yields too – but their hefty upfront commissions will drag their returns to sub-FD levels eventually.

Barring a few rare government-subsidized schemes such as the Pradhan Mantri Vaya Vanda Yojana (PMVVY), very few traditional life-insurance plans are worth shifting your FD money into. FD transitioners should stay away from them and spare themselves the heartache.

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Fixed Deposit Fixed Deposit Investors