Alternative to FD for the short term?

May 6, 2019

I want to invest Rs 15 lakh, which I may not need for 6-9 months. I am looking for an alternative to fixed deposits. Please recommend mutual funds.

1 Answer
May 6, 2019

This is a very common question and most people are not aware of alternatives to FDs. I am going to assume that when you say FDs, you mean bank FDs. I am also assuming that your objective is to get a higher return than FDs and that you want to your investments to be available readily when required. Before I get to the available options there is 1 thing that you must consider - risk. If you are looking for higher returns then you should be willing to take a higher risk i.e. you should be ready to suffer a loss (unlikely but possible).

Now lets talk about the available alternatives.

Liquid & Ultra Short Term Funds

Consider investing in liquid and ultra short term debt funds. At the current rates, liquid funds give you a return of about 7.2%. Ultra short term debt schemes will give you slightly higher returns, 8-9%. While liquid funds invest in schemes with upto 90-day maturity, ultra short term funds invest in instruments whose maturity can be between 3-6 months.

Most liquid funds and ultra short funds do not have any exit load (penalty for exiting the investment within a pre-defined period). However some may charge you an exit load if you liquidate your units within 7 days. You should always confirm this from the scheme document before investing.

These funds carry a higher risk than a bank FD. Since these funds lend money to corporates, the fund performance will suffer if any of these corporates defaults on their debt obligations. Some incidents of default from the recent past - Amtek Auto (2015), IL&FS (2018), Essel Group (2019). After the IL&FS default in September 2018, the NAVs of few debt mutual funds suffered, resulting in losses to their unit holders. For some funds the loss was as high as 6%.

Overnight Funds

Explaining overnight funds in depth would make this answer too long. Brief explanation - these funds invest in debt instruments which mature in 1 day! Their returns are lower than those of liquid funds but the credit risk is also much lower. At current rates overnight funds would give you a return of about 6%.

Liquid ETFs

There are liquid ETFs like Reliance Liquid BeES, DSP Liquid ETF, and ICICI Pru Liquid ETF. They invest in instruments like CBLO (Collateralised Lending & Borrowing Obligation), repo/reverse-repo. These funds give out a daily dividend (in the form of ETF units into your demat account) which are compulsorily re-invested in the fund. There is a dividend distribution tax (DDT) of 29.12%. Currently such funds give a post-DDT return of 5.4%. Since dividends are tax free in the hands of the investor, there are no further taxes (dividends upto Rs 10 lakh are tax free). So this is only suitable if you are in the 30% tax slab. The returns might be lower as compared to a liquid fund, however the credit risk is also considerably lower.

Once you have decided the category to invest in, the next step is choosing the fund to invest in. This will depend on the track record of the fund manager and one will have to check if the portfolio of such funds contain any low rated securities. So the right choice today may not be the right choice 6 months or 1 year down the line. Either do your own research or contact an investment advisor.

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Financial Planning for a 30 year old salaried employee

Sachin Shah is a 30 year old Senior Software Engineer, working at an IT services company in Bengaluru. He and his wife want to plan for their retirement and also want to save for their child's education, wedding and for buying a car.

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