A bank recurring deposit is just like a bank FD. The only difference is that while in an FD you contribute the entire deposit as a lump sum, in a recurring deposit (RD), you can contribute at regular intervals like monthly or quarterly. The advantage in an RD is that it allows your contribution to match the periodicity of inflows. For example, if you get your income on a monthly basis, then have a RD with due date on the 5th of every month can be a good idea. It not only instills the savings discipline, but also synchronizes your inflows with your savings.
Mutual fund SIPs – How they are similar to RDs
The equity equivalent of a bank RD would be the systematic investment plan (SIP) in an equity fund. Of course, you can do a SIP on an equity fund or in a debt fund but for the sake of simplicity, let us consider the equity fund SIPs here. That means; if you are saving on a regular basis, then you have the choice of RD versus SIP. Which should you choose? Your choice will be based on 6 key factors.
- In terms of choice and flexibility, there are sufficient options available in both these instruments. If you invest in an RD, you will earn a fixed rate of return that will be lower but will be assured irrespective of the market conditions. You have choice in the sense that you can choose between fixed RDs or even flexible RDs depending on how you wish to contribute. Even SIPs in mutual fund offer you a choice between debt and equity funds depending on your time frame and your risk appetite. SIPs also give you the choice between fixed SIPs and step-up SIPs where you can increase your SIP by a fixed amount each year based on your expected income growth.
- How RD and mutual fund SIPs fit in terms of risk profile? To begin with, recurring deposits are as safe as bank FDs and are not prone to risks. In fact, it is one of the safest forms of investment. However, when you invest in mutual fund SIPs (equity or debt); you can expect volatile and variable returns from the SIP. There can even be a risk of capital and returns depending on the vagaries of the stock market, debt market and the credit risk as we saw in cases like IL&FS and DHFL.
- Recurring deposits are normally having a periodicity of one month. Such monies have to be deposited in the RD each month. On the other hand, the Systematic Investment Plans are a way to put your money on mutual funds and are a lot more flexible. SIP investment can be done on a daily, weekly, monthly or quarterly basis depending on the structure of your cash inflows.
- In terms of returns, you need to look at the time frame aspect. Over the shorter term of up to 2 years, RDs can give returns of around 6-7% on an assured basis without any volatility of returns. As the rate of interest is fixed in a recurring deposit scheme, the return is also fixed and known at the time of investment. But, returns can be a lot more volatile in case of SIPs. In fact, debt fund SIPs are ideal for a holding period of 3-5 years while equity fund SIPs are ideal if the holding period is more than 8 years. Otherwise, the risk adjusted returns of SIPs will not be too compelling.
- Liquidity is available in both the RD and the SIP. SIPs can be redeemed at any point of time although the capital risk is there in the short term. Even RDs can be prematurely withdrawn or you can also take a loan against the RD deposit. Recurring Deposit is liquid but premature withdrawal or closure will attract penalty charges.
- Finally, let us look at the taxation aspect. This is where the SIPs really score. Interest earned on Recurring Deposit is fully taxed as income and your peak rate of tax is applicable in this case. The other hand, SIPs have some advantages. Debt Fund SIPs give you the benefit of indexation in case of long term gains. In case equity SIP gains, STCG is taxed at a concessional rate of 15% and LTCG at a concessional rate of 10% above Rs.1 lakh per annum. One can also invest in ELSS SIPs where you can get the additional benefit of exemption of the contribution under Section 80C for the amount contributed each year to the extent of Rs.150,000 overall.
In a nutshell, RDs are good debt products if your time frame is 1-3 years. If your saving goal is for the longer term, SIPs of the appropriate asset class can fit better.
Infini MF App is available on Google playstore and Appstore!