Updated on: Sep 21st, 2023 | 8 min read
A fixed deposit scheme helps you invest a lump sum of money for a fixed tenure and at a fixed interest rate. This allows you to earn guaranteed returns, regardless of market volatility. Hence, they are preferred by investors who have a low-risk appetite.
Fixed deposits fall in the debt instrument category. Like them, other debt instruments available in the market help you save and earn a stable income on your savings. The debt market is, therefore, extensive, enabling you to choose from a wide range of options that can act as alternatives to fixed deposit accounts. These alternatives have different features and benefits, but the returns remain constant. Some can even deliver better returns and offer tax benefits to help you create a higher corpus.
Read on to know more about alternatives to FDs.
Here’s a look at the top 9 alternatives of FDs that you can invest in:
1. Debt mutual funds
Debt mutual funds invest primarily in debt instruments. Like a regular mutual fund, it offers a diversified portfolio managed by professional fund managers. Since the fund invests in debt, the credit risk is lower in comparison to equity mutual funds, and you can earn inflation-adjusted returns. There are 16 different types of debt mutual funds, the prominent ones being:
Short duration funds
Medium duration funds
You can invest in these funds depending on your financial goals and investment horizon.
When it comes to returns, you get an indexation benefit if you redeem your investment after 36 months. This benefit considers the effect of inflation and reduces your tax liability on long-term capital gains.
2. Government securities
Government securities are one of the most secure debt instruments you can choose. These securities are usually issued for the long-term and earn a stable return. So, if you want to invest your money for a longer tenure, Government securities can be a good avenue.
3. Corporate bonds
Corporate bonds are debt instruments issued by companies in need of funds. These bonds carry a fixed rate of interest. Most corporate bonds are also traded on the stock exchange, making them liquid and thus providing liquidity whenever needed.
4. Corporate fixed deposits
Corporate fixed deposits are similar to fixed deposits with banks with some key differences. The primary difference is that, unlike bank FDs, these are accepted by Non-Banking Financial Companies (NBFCs) specifically allowed by RBI. Moreover, corporate fixed deposits have a higher interest rate compared to bank deposits. One other key difference is corporate FDs are not insured by DICGC and in case of the corporate becoming insolvent, you may lose your entire investment. Corporate FDs have ratings that assert their stability, like AAA, AA+, etc. The higher the rating, the more secure the deposit.
5. Recurring deposits
Unlike fixed deposits, recurring deposits require deposits at regular intervals, say monthly, over the chosen tenure. You choose the amount you want to deposit and the term of the deposit. For example, you open a recurring deposit account of Rs.1000 for five years. You would have to deposit Rs. 1000 monthly for the next 60 months. The account will mature after five years when you get a lump sum that includes the invested amount and the returns earned thereon.
6. National Savings Certificate (NSC)
The National Savings Certificate is another savings instrument that gives stable returns on your investments. These are available through Post offices and authorised bank branches. The lock-in period of NSC is five years, and the Government determines the interest rate. The interest rate for the quarter starting Oct 2022 is 6.8%. You can enjoy tax benefits under Section 80C of the Income Tax Act, 1961, thus helping you reduce your taxable income. You can claim a deduction on investments up to Rs.1.5 lakhs and reduce your tax liability by up to Rs.45,000 (if you fall in the 30% tax bracket).
7. Bharat Bond ETF
Exchange Traded Funds (ETFs) are instruments similar to mutual funds, except that they can be bought and sold on exchanges, like stocks. The Bharat Bond ETF is a unique ETF which invests in bonds issued by public-sector undertakings, i.e., companies owned and managed by the Indian Government.
There are different types of Bharat Bond ETFs based on the maturity of the underlying assets. For example, Bharat Bond ETF 2023 invests in bonds with medium-term maturity. On the other hand, Bharat Bond ETF 2030 invests in bonds that have long-term maturity.
The ETF invests in high-rated bonds of Government companies – a trait that makes it risk-free. You can buy and sell the ETF at your convenience as there is no lock-in period. The minimum investment is Rs.1000, while the maximum is capped at Rs.2 lakhs.
Similar to debt mutual funds The returns earned enjoy an indexation benefit if you hold it for more than 3 years, thus making them tax-efficient.
8. Public Provident Fund (PPF)
The Public Provident Fund is a popular investment avenue for resident Indians. It has a lock-in period of 15 years, wherein you have to invest every year to keep your account active. You can also extend the scheme’s maturity in blocks of 5 years if you want to stay invested for a more extended period.
The minimum investment amount is Rs. 100, while the maximum is capped at Rs. 1.5 lakhs. Like with the NSC scheme, the government fixes and reviews the interest rates for the Public Provident Fund as well. The current interest rate is 7.1% for the Oct-Dec 2022 quarter.
Apart from partial withdrawals, loan against PPF can also be availed upto some limit. The amount you invest in the PPF account is allowed as a deduction under Section 80C. The interest earned and the maturity amount are tax-free, making the PPF scheme the most tax-efficient of all debt instruments.
9. Fixed Maturity Plans (FMP)
Fixed Maturity Plans are a type of debt mutual fund, but with a twist. These funds are issued for a specified tenure, which acts as their lock-in period. You cannot redeem the fund before the tenure. The term of the fund mirrors the tenure of the underlying securities. For instance, if the FMP has a term of one year, the securities in which it invests will also have a one-year term.
FMPs are low-risk investments that also offer the indexation benefit if you redeem them after 36 months.
In the case of fixed-income securities, lower interest rates mean lower returns. So, as the interest reduces, returns also fall; this is true in the case of securities like the NSC, PPF, etc., whose rates are determined quarterly. However, with fixed deposits, the interest, once set, does not change even if the interest rates fall.
On the other hand, securities traded on the stock exchange, like bonds, enjoy higher prices when interest rates fall. As such, you can sell your bonds in the stock market for a higher rate.
Thus, a falling interest rate can be a negative factor for some alternatives to FD while a positive factor for others.
If you want to diversify your portfolio, you can opt for any of the alternatives mentioned above to FDs. Understand the pros and cons of each option, align it with your goals and investment horizon, and then make the right choice.
Can I sell bonds before their maturity date?
If a bond is listed on the stock exchange, you can sell it off before its maturity date provided the bond is actively traded. However, remember that the price of the bond varies constantly. So, you might get a higher or lower price when you sell the bond on the secondary market, depending on the current interest rates in the economy.
How are debt mutual funds taxed?
In the case of debt mutual funds, the holding period is considered to calculate the tax liability. If you redeem your investment within 36 months of investment, the returns that you earn would be called short-term capital gains. Such gains are added to your taxable income and taxed at your income tax slab rates.
On the other hand, if you redeem after 36 months, you earn long-term capital gains. Such gains are taxed at 20% with indexation benefits.
Do I get a tax benefit for investing in FDs and their alternatives?
5-year fixed deposits offer tax benefits on investments. The investment is allowed as a deduction under Section 80C up to Rs. 1.5 lakhs. Other alternatives to FDs, like the PPF scheme and the NSC, also offer the same benefit. Tax benefits for alternatives to FDs differ from scheme to scheme.
Are corporate FDs and normal FDs the same?
NBFCs offer corporate FDs, while banks and post offices provide regular FDs. Moreover, corporate FDs are not secured against the RBI’s insurance cover of Rs.5 lakhs; they don’t earn tax benefits on investments under Section 80C or offer tax-free interest to senior citizens under Section 80 TTB. In contrast to bank fixed deposits, corporate fixed deposits usually offer higher interest rates.
Can NRIs open a PPF account?
No, NRIs are not allowed to open a Public Provident Fund account. The PPF facility is only available to resident Indians.