INSUBCONTINENT EXCLUSIVE:
As is usual when something like this happens, there followed a noisy discussion about interest rates, inflation and growth
It was more or less a repeat of numerous such discussions over the past decade, and neither overly useful or entertaining.
Disappointingly,
just as in the previous rounds of this same identical discussion, there was little attention paid to the function of interest rates as the
sole source of investment income for a large proportion of small savers
Let us, for the moment, forget about growth-vs-inflation tradeoff for the moment and look at the first, direct effect of lower interest
That effect is lower income for lenders and lower cost for borrowers
So who is the biggest borrower in the country? Obviously, the Government of India
And who is the biggest lender? The people of India, directly or indirectly
In terms of savings, India is still very much a fixed income country, and the tens of crores of people have all their financial savings in
bank FDs, PPF, post office deposits and such
what lower rates mean for savers
Savers need a real rate of return at least two or three per cent higher than the consumer inflation
When you lower the retail rates from, say 7 per cent to 6.5 per cent, 8 per cent of their income is gone.
Unfortunately, there is no real,
substantive solution to this problem which does not involve equity
Ideally, even a reasonably conservative hybrid fund, held for a period of three to five years and above, would solve this problem
However, the variability of the value is a psychological barrier that savers of an older generation cannot cope with
I find that younger investors, for example those who have been investing in ELSS funds get well-used to such variability
They learn the lesson that there may be ups and downs in equity-backed funds but eventually the gains are good
However, even if they stick to fixed-income sources, such savers to do well to learn another lesson from mutual funds, which is that
tax-efficiency matters a lot
The benefits of using mutual funds funds go beyond just returns
The tax difference arises from the fact that returns from fixed deposit are classified as interest income while mutual fund returns are
classified as capital gains
Under interest income, you have to pay tax every year for the what you earned that year
If your total interest income from a bank (all accounts and deposits together) exceed Rs 10,000 then the bank also deducts TDS at 10 per
In fact, if the bank does not know your PAN, it will deduct 20 per cent
This means that a part of your return is not available for compounding because it is taken out and paid as tax every year.
There is a
further advantage to the mutual fund option if you stay invested for more than three years
If you redeem after three years, then the gains are classified as long-term capital gains and are taxed after indexation
Essentially, you get taxed only on inflation adjusted returns
Again, this does not happen with FDs
Applying all these factors, a three year investment even in shortest-term debt fund will leave you with almost twice the returns as an FD
