How can you generate higher returns on savings after interest rate cuts?

Karan Deo Sharma
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How can you generate higher returns on savings after interest rate cuts?

How can you generate higher returns on savings after interest rate cuts? 30 stades, investment, save money,grow money,

The Reserve Bank of India (RBI) announcement last week that it will stop issuing 7.75 percent (taxable) bonds - commonly known as RBI 7.75 percent bond - is the latest blow to the savers and fixed income investors in India. In fact, savers are up against the might of global central banks, including RBI, which continue to push interest rates down, lowering the yield on all savings instruments -- bank deposits, post office deposits or government bonds.   

RBI policy rate has halved in the last five-years from 8 percent at the beginning of 2015 to 4 percent now.

This has led to yield suppression across the board starting from the government bonds. For example, the yield or interest rate on 10-year government of India bonds is now down to 6 percent from around 8 percent at the beginning of 2015.  

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More importantly, the interest on your savings bank deposit is now down to 2.25 percent from 4 percent until recently.

Economists see a further compression in yields as Indian economy slips into a recession, hitting government revenues. Both the central and state governments plan to borrow massively in the current fiscal year and interest payment on these borrowings will become unsustainable if interest rates are allowed to rise. Given this, economists expect the RBI to keep interest rates down.

This makes the task of risk-free savings and investment even more difficult for common folks. While it's not easy to replace the risk-free return offered by RBI bonds or what a 5-year tenure bank fixed deposits say offered in 2014-15, here are a few alternatives.

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1.    The easiest way is to invest in high yielding but equally safe instruments such as post office deposits. At 5.8 per cent for five-year tenure, yields are better than what banks offer on their deposits.

If you invest in post-office deposits through authorised agents, they give cash back of 1 percent, which pushes-up the yield on post office deposits to 6.8 per cent.

2.    The second option is to take some risk and move some of your savings to corporate deposits. Many companies, especially non-bank lenders like Housing Development & Finance Corporation (HDFC), Shriram Transport Finance, Bajaj Finserv, LIC Housing Finance, M&M Finance and Edelweiss Capital offer fixed deposits and recurring deposit schemes. The interest rates on corporate deposits are 100-150 basis points higher than what banks offer. 100 basis points is one percent.

 However, keep in mind that corporate deposits are riskier than bank deposits and they are not regulated by the RBI. If the company goes bankrupt you can lose your entire money unlike commercial banks. But you can minimise your risk by sticking to large and reputed firms that are AAA –rated.

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You can check a company’s latest credit rating on the website of leading rating agencies such as CRISIL, ICRA, CARE Ratings and India Ratings.

You can also de-risk your portfolio by dividing your money across say 4-5 different firms which will also allow you to raise the potential yield on your investment. For example, HDFC – the top rated non-bank lender – offers 6.83 percent interest on 44 months deposits. In comparison, Shriram Transport Finance which is rated AA+ by Crisil – a notch below HDFC – offers 8.5 per cent interest on a 5-year deposit.

As a thumb rule, don’t invest in companies with a credit rating of AA or below.

3. The third option is to mix fixed deposits or debt with high dividend paying stocks. Reduce the share of fixed deposits in your portfolio and increase allocation to high dividend paying stocks. If you are not older than 45 years and can afford to take some risks, you can put up to 50 percent of your savings in dividend stocks. But it’s not advisable to go beyond this limit.

Unlike fixed deposits where interest is fixed for the entire tenure, dividend pay-out by companies grows year-after-year in line with the growth in company’s profits.  This means that yield on your initial investment will continue to rise and could even surpass the yield on bank FDs if you hold the stocks for five years or more.

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A back of the envelope calculation suggests that a stock or portfolio with initial dividend yield of 5 percent will yield around 8 percent in the fifth year and 14 percent in the 10th year provided dividend pay-out grows at an annualised rate of 12 percent on an average. And if the initial yield is three per cent, it will grow to 8.3 per cent by the 10th year.

This is not some outlandish claim. In the last five-years, dividend payout by leading companies such as Tata Consultancy Services, Infosys, HDFC Bank, HDFC, L&T, Power Grid Corporation and Maruti Suzuki has grown anywhere from 12-20 percent.

As the interest rates go down, the era of passive savings is over.

You will now have to become an active investor and continually search for new instruments and rejig your portfolio at least once a year if not more.

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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