Short term savings products

If you wish to invest your money for short periods of time (up to 3 years), there are various financial products available. Some of the more popular ones are bank deposits, recurring deposits, some mutual fund products. All these

Bank Deposits

A bank deposit is similar to a savings account. Like with a savings account, when you open a bank deposit, you need to fill in a form and provide proof of identity and proof of residence and two photographs. If you already have a savings account with the bank, you may not be required to give these details.

The main difference between a savings account and a deposit is that in a deposit you cannot withdraw your money as and when you please. If you need to withdraw money in an emergency, you can do so by paying a small penalty. You also cannot keep adding to the amount you’ve deposited (unlike in a savings account where you can do so). Your money, which is called the principal, is kept in this account for a period of time that you specify at the time of opening the account. The period can be a few months, a year, or a few years. At the end of the period, the money gets automatically deposited in your savings account. If you do not have a savings account with the bank, you can receive the amount in cash.

The interest that you receive in a bank deposit is greater than that offered on a savings bank account. You can either receive your interest at regular intervals – perhaps every month or every six months or once a year or get it at the end of the period as one lump sum amount with your principal amount.

Features of a bank deposit

• Return: The rate of interest is fixed in advance. It varies slightly from bank to bank. The interest is higher than the savings account interest. Interests are usually in the range of 6-10% per annum. The rate of interest that you receive is also linked to period for which you plan to keep your money in the bank deposit.
• Risk: Minimum risk. Bank deposits are backed by the RBI up to an amount of Rs. 1 lakh per person per bank.
• Liquidity: You can withdraw your money if you need to. However, you may be required to pay a small penalty. The penalty is usually in the form of a deduction in interest rate. For example, if you had invested for a period of 2 years at an interest of 8% and you decide to withdraw the amount at the end of 1 year, you may earn an interest of only 7%. The penalty could also be a small percentage of the amount of your deposit.
• Tenure: You can decide on the tenure (i.e. how long you would like to deposit your money) from amongst various tenure periods offered by the bank. Most banks offer you 4-6 tenure options to choose from. These can range from around 1 year to 5 years and even more.
• Taxes: The money that you receive as interest on your principal must be added to your other taxable income and is taxed at the rate applicable to you.

Recurring deposits

Banks also offer their clients the option to open a deposit where you do not have to deposit a lump sum principal amount but can contribute a fixed amount at regular intervals – such as monthly or yearly. Just as in the case of a bank deposit, you cannot withdraw your money before the end of the tenure, without paying a small penalty. For example, you can deposit Rs. 500 every month for 3 years. At the end of three years, you will receive not just the amount that you have deposited over the years but the interest as well.

Features of a recurring deposit

• Return: The rate is fixed in advance. Varies slightly from bank to bank and is linked to some standard rates used in the banking system. It could be in the range of 6-10% per annum. The rate of interest that you receive is also linked to the amount of time for which you plan to keep contributing to the recurring deposit.
• Risk: Minimum risk. Recurring deposits along with the amount in your savings account and bank deposits and are backed by the RBI up to an amount of Rs. 1 lakh per person per bank.
• Liquidity: You can certainly withdraw your money if you need to. However, you may be required to pay a small penalty. The penalty usually means that you may lose some part of the interest that you would have been due, if you had kept your deposit with the bank for as long as you had originally decided to. Alternatively, this could be a small percentage of the amount of your deposit.
• Tenure: You can decide on the tenure (i.e. how long you would like to deposit your money) from amongst various tenure periods offered by the bank. Most banks offer you 4-6 tenures to choose from and these range from around 1 year to 5 years and even more.
• Taxes: The money that you receive as interest must be added to your other taxable income and is taxable at the rate of tax applicable to you.

Mutual fund products

Very often, people would like to invest in certain financial products, such as stocks or bonds. However, due to lack of knowledge or time they avoid doing so. Sometimes, the amount of money that they would like to invest is not enough to allow them to purchase a significant amount of units.

A mutual fund is a financial product that allows individual investors to buy such products indirectly. With mutual funds, money is collected from thousands of investors. The money collected is then invested in some financial products according to a pre-stated objective. For instance, the objective may be to invest only in government bonds or it may be to invest in a mix of stocks and bonds in a particular ratio. Some mutual fund schemes may have the objective of investing in certain sectors only, for example, banking, pharmaceuticals, software, etc. There are plenty of schemes from different mutual funds with different objectives. You can invest in a mutual fund scheme whose objectives suits your investment need best. In order to keep a track of how much each investor has contributed to the fund, each investor is given a number of units. Each unit represents Rs. 10 invested in the fund. If you invest Rs. 1000 in the fund, you will be allotted 100 units of that fund.

The value of your mutual fund units may vary from day to day. This is because the values of the products (shares of different companies, interest rate on bond, etc.) that the fund has invested in vary. Accordingly, the value of the whole fund varies. Once a year, it may pay you some part of the profit, if it has made any. This is called a dividend. Alternatively, you can choose an option where you do not receive any dividend, but the value of the fund, and therefore the value of your units keeps increasing. You can make a profit by selling your units at a higher rate than what you bought them for.

You can find out the value of your units by checking the Net Asset Value or NAV of your scheme on the website of the mutual fund house. You can buy mutual fund units from a mutual fund company and sell them on any working day. The price that you have to pay will be the NAV. When you sell your units, you will receive the NAV per unit. Here you may need to pay a small percentage of the total value as an exit load.

Features of mutual fund

• Return: It is not fixed in advance. It varies from scheme to scheme and depends upon the performance of the products in the particular scheme. Short term schemes that invest in government backed products usually offer a return of anywhere between 3% and 8%. Sometimes, it could be more or less than that. Performance of mutual funds that invest in shares can give returns above 15% in a good year or fall more than 15% in a bad year.
• Risk: There is no security of the amount that you invest. It could increase or decrease depending on the performance of the products in which the fund invests.
• Liquidity: You can sell off your units on any working day and you will receive the amount due to you within 3 working days. This is true for all mutual funds except Equity Linked Saving Schemes (ELSS) funds. With ELSS schemes, you get tax benefit under Section 80C, but at the same time, you can only sell them after 3 years of buying them.
• Tenure: There is no fixed time frame for which a scheme lasts. Investors have the freedom to buy or sell units to the mutual fund company anytime they would like to.
• Taxes: The money that you receive from a mutual fund company in the form of dividend or profit once a year is tax free. The tax payable on the profit you make when you sell your funds, if any is treated as capital gains and taxed depending on how long you have held your mutual fund units. If it is for less than 1 year, you have to pay short term capital gains tax. If it is for more than one year, you have to pay long term capital gains tax.

Source: Portal Content Team