Bank FDs vs liquid funds: Which is a better investment?

Many banks have increased the interest rates on fixed deposits (FDs) after the Reserve Bank of India (RBI) raised the policy repo rate by 50 basis points (1 basis point is one-hundredth of 1%) to 4.90%. The largest state-run lender, State Bank Of India (SBI) has hiked the interest rate by 20 bps from 4.40% to 4.60%. On term deposits of 1 year to less than 2 years, SBI now offers an interest rate of 5.30%, up from 5.10% earlier. Two-to-three-year deposits will now fetch 5.35% interest, up from 5.20% previously.

Country’s biggest private lenders — HDFC Bank and ICICI Bank have hiked rates too. The highest FD rate, as per BankBazaar.com, among the top banks in India is 7% p.a., which is given by Deutsche Bank for tenures ranging from 3 years to 7 years for the general public.

Will the increase in FD rates bring back their popularity? Is it time to invest in them? Experts are not convinced yet!

FDs have witnessed almost 40% fall in their rates in the last 6 years from 2014 to 2020. After the repo hike, the banks have increased their lending rates and some have increased the FD rates as well. But the transmission, says Manish Kothari, co-founder and CEO, ZFunds, will not be that quick in FDs to pass on the entire benefit to investors. “The current FD rates are still under 6% and we feel FDs will not be an attractive option till it starts giving more than 7%,” he says.

The current FD interest rates are unable to beat inflation and can erode wealth overtime.

The real rate of return, given the high inflation rate, is still negative, says Anil Rego, founder and fund manager, Right Horizons PMS, and returns can be even lower if you are in a higher tax slab. Also, Rego doesn’t expect the interest rates to go back to the earlier highs either.

Consumer price inflation has been running above the RBI’s upper threshold of 6% since the start of this year averaging at 6.72% between January-April 2022. RBI’s own estimate of average inflation in the fiscal year 2022-23 has been revised higher from 5.7% to 6.7%. The RBI is now squarely focused on bringing down inflation.

Bank FDs suitable for conservative investors

Some banking experts believe bank deposits are suitable for investors with a moderate to low risk appetite who may find the equity markets unattractive. There will be volatility in the equity markets, as per Sanchay Kumar Sinha, country head – liabilities and branch banking, South Indian Bank, for some time on account of the U.S. Fed’s decision to hike policy rates by 75 bps. Also, there are fears in some quarters about global inflation triggering unemployment. With interest rates on FDs predicted to touch 8% by December, says Sinha, retail investors can regard it as an attractive investment.

Senior citizens in lower tax brackets, says Anil Rego, can consider looking into FDs as banks offer slightly higher returns to them on fixed deposits.

Bank FD laddering for higher returns

Those willing to invest may ladder their funds in short-term FDs. “Laddering FDs for the short term will give you periodic liquidity as well as the ability to move to a higher interest rate when you reinvest on maturity,” says Adhil Shetty, CEO, BankBazaar.com.

Laddering is an investment strategy in which investors purchase bank fixed deposits with different maturity dates to gain from the rising interest rates scenario. So, as per Shetty, booking short-term FDs and then reinvesting them for longer terms over the next few months would be a good strategy.

Liquid funds, a better option

Liquid funds would be better than bank deposits for investors at this time given the expected repo hikes in future, says Kothari of ZFunds. Liquid funds invest in debt and money market securities with maturity of up to 91 days only.

Year-to-date, liquid funds have delivered 1.69% returns. In the last year, these schemes on an average have given 3.45% returns.

While past returns may not be very healthy for debt funds, as per Anil Rego of Right Horizons PMS, the yield to maturity (YTM) of mutual funds has gone up significantly and is likely to be better than FDs with a tenure over one year. YTM of a mutual fund scheme is the tentative return that one can expect by holding the bond till maturity.

Rego adds that investors may also look at categories like floating rate funds which will automatically benefit from intermediate interest rate hikes. So, considering the current scenario it is advised to look into debt funds of shorter duration and floater funds, he says.

As per Kothari, short term funds could be avoided for now given the slightly higher durations, the returns of which can be impacted in the event of rate hikes. “Eventually investors can move from liquid to short term once the repo hike situation settles.”