Small Savings Schemes

During February 2016, the Government of India had announced  that it will review small savings interest rates every quarter  based on the yields of government bonds of the previous three months.Recently the government has reduced  interest rates on small savings schemes  to align them with market for the quarter beginning 1 April 2017.

The commercial Banks were reluctant to pass on the policy rate cuts by RBI citing the higher small savings rate. Now this linking of interest rates of small savings schemes to the yields of government securities and reduction in rates will prompt the banks to  pass on the policy rate cuts to the borrowers  through lower lending rates.

The  rates have been reduced  by 10 bps of all small savings schemes including PPF,senior citizens’ saving scheme, postal time deposits, KVP,NSC and Sukanya Samriddhi  excluding the Postal Savings account which has been retained at 4%.The Government has  also retained the spread of 25 basis points of long-term savings schemes such as the five-year term deposit and National Savings Certificates (NSC)  etc over government securities of comparable maturity  to encourage long-term savings.

Implications

When Financial Planners  approach portfolio construction of the clients, they try to optimize on different parameters; risk appetite, goal horizon, rate of return, safety, liquidity and taxability.

The capital is protected if the investment provides real rate of return.The real rate of return is the return over and above the inflation rate. In the pastwe have seen Banks were offering lesser interest on FD than  inflation rate and this was resulting in negative rate of return.Currently inflation is coming down and the central bank is targeting long term inflation of 4%.So interest rate above inflation will generate  real rate of return.We should be looking at real rate of return and not at absolute  interest rate.Market linked equity can provide better return but it carries risk of volatility and suitable for investors having higher risk appetite.

Small savings scheme comes top on safety and suitable for  investors having lower risk appetite.Liquidity is available for postal savings bank account but exit from other small savings comes with restrictions. On liquidity, Liquid Mutual Funds are a better option.

PPF is an EEE (Exempt Exempt Exempt)scheme and will provide 7.9% tax free return for the coming quarter. A reduction of 10 bps is small and should not influence discontinuance from the scheme. But investors having higher risk appetite can opt for ELSS which scores over PPF on both on historical return and lock in parameters. There are 3 years lockin in case of ELSS where as PPF can be withdrawn after 15 years.

Senior Citizen scheme is preferred by retired people but has a cap of Rs15 lakhs on investment per person. Sukanya Samridhi is preferred for education need of the girl child.Postal Time deposit,RD and Kisan Vikas Patra schemes are popular in rural areas where banking facilities are not available.All these schemes are good for investors having conservative(low) risk appetite.

According to the finance ministry notification,  five ­year National Savings Certificate (NSC) will provide interest of 7.9% instead of 8%. KVP investments will now provide 7.6% return and mature in 113 months. The scheme for the girl child, Sukanya Samriddhi  Account Scheme and five­ year Senior Citizens Savings Scheme will provide 8.4% return. The five ­year monthly income scheme will offer 7.6% return.  The five year recurring deposit will earn 7.2% interest. But all these except PPF  are taxable and hence not suitable for investors in the highest tax bracket. They should look for  investing in a debt mutual fund instead, if the time horizon for investment is more than three years. Debt mutual funds will   provide  similar  return, but  indexation benefit after 3 years  will increase the overall return.

Way Forward

Risk appetite; Risk tolerance varies across investors. The investors’ categories are aggressive, moderate or conservative. The aggressive investors believe in higher the risk, the higher the return” but at the same time they are ready for absorbing  loss. The conservative investor cannot tolerate loss and hence should be satisfied with risk free and average returns. Small savings schemes are suitable for these  category of investors.

Goal based investing; The first question to be asked before investment is for what goal should you invest? The goals may be Children’s education/marriage, Retirement corpus, Buying a house etc. Investing for a goal provides answers on horizon of the goal. The longer the goal horizon, the lesser the volatility of the performance in equity due to mean reversion.Longer duration MTM debt products are also impacted by changes in interest rate.Small savings schemes can be preferred for short duration goals.

Asset allocation; Warren Buffet’s saying goes “Do not put all your eggs in one basket”. Different asset classes’ i.e equity, real estate, debt, gold, commodities etc perform in varying degrees in different market periods.  Remaining invested in different asset classes will ensure diversification of the risk and hence bring stability in returns. Small Savings schemes come under Debt exposure and should not exceed the age of the investor.

Rebalancing; Once asset allocation is arrived at, it is advisable to periodically review it and restore the balance. For example, if the original Equity: Debt allocation is 60:40 and rally  in the equity market makes it 65:35;it is advisable to book profit in equity(5%) and invest the amount in Debt including in small savings scheme.

Finally interest rate of small savings scheme will get reduced in the coming days and investors should look at taking advice from professional investment advisers before making investment decisions.

                                                                                                                                  (The article has published in Financial Chronicle on dated 17th April 2017)

Last modified on Tuesday, 18 April 2017 06:45

Prakash Praharaj

Shri Prakash Praharaj has a passion for excellence. He has been awarded two gold medals for securing top positions both in Graduation and Post Graduation in Commerce. He is an MBA with specialization in Finance and marketing. He has been awarded Diploma in Treasury, Investment and Risk Management besides CAIIB from the Indian Institute of Bankers. He is a Certified Financial Planner from the Financial Planning standards Board, India (FPSB), affiliated to FPSB, Denver, USA and Certified Personal Financial Adviser from NISM. He is also a SEBI registered Investment Adviser vide Reg. no. INA 000000045 dated 2nd August 2013.His book "Your Every day guide to Personal Finance and Insurance" has been published by CNBC TV 18 in August 2015.

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