My parents recently gifted my sister Rs 50,000 on her birthday. On the condition that she invest it and not "blow it up". She first contemplated the stock market but decided that it was too volatile right now.
Where mutual funds are concerned, she had already opted for an SIP. In case you are unaware, when you invest fixed amounts every month in a mutual fund, it is referred to as a Systematic Investment Plan. This money gets directly debited from her bank account every month.
So she finally decided to invest in some fixed-return investment. Read Why it's time for a fixed deposit.
This could be the Public Provident Fund, National Savings Certificate, Kisan Vikas Patra (post office), fixed deposits (company and bank) and bonds.
If these investments are your cup of tea too, then here are some factors you should look at before you invest.
To elucidate, let's assume:
Rate of interest = 8% per annum
Principal amount invested: Rs 50,000.
Regular return investment
The interest rate of 8% on Rs 50,000 will amount to Rs 4,000 every year. This amount will be paid to the investor.
Since the investment gives a regular return, the principal amount remains the same (Rs 50,000), there is no growth.
What you will get every year: Rs 4,000
What you will get at the end of the investment: Rs 50,000
Total interest earned: Rs 20,000
This is good for people who need a regular income. But if you are working and have a steady job, then the regular income is not necessary.
Cumulative return investment
Here the interest keeps getting added to the principal and the principal amount keeps increasing.
The interest earned every year (Rs 4,000) will be added to Rs 50,000 and next year's interest will be calculated on Rs 54,000. When the interest on Rs 54,000 is added the following year, it amounts to Rs 58,320, so on and so forth.
So every time the interest is added, it is more than the previous time. This is known as compounded interest.
What you will get every year: Nothing
What you will get at the end of 5 years: Rs 73,466
Total interest earned: Rs 23,466
If you opt for a lump sum at maturity you earn much more.
Recurring investment
Just as above, the interest is compounded. In addition, not only is the interest earned added to the entire amount, but even Rs 500 per month is added.
What you will get every year: Nothing
What you will add every month: Rs 500
What you will get at the end of 5 years: Rs 1,09,938
Total interest earned: Rs 29,938 (1,09,938 50,000 30,000)
So with a cumulative investment, your money works hard for you. And with a little nudge by way of regular additions, it works even harder.
Rs 500 every month does not pinch one's wallet too much. Over five years, this amounts to an investment of Rs 30,000 (Rs 500 x 60 months). Yet, this is the best option because you do not have to put in the money at one go. You can do so with small amounts. And, it inculcates a savings habit.
Verdict: Opt for a cumulative investment and if possible, take a recurring deposit route. This allows the interest to feed on the earlier interest earned and the small additions.
What else to look for
1. Tenure of the investment.
Can you block your money for many years or would you need it after a few years? For instance, PPF is for 15 years but NSC for six years. And, of course, bank deposits are from 15 days to over eight years.
2. How interest is calculated.
Is the interest compounded once annually or twice? If it is once, then the next year's rate of interest will be levied on the all the interest earned in the year. But, if compounded twice, then after every six months interest is given and further calculation is based on this.
So if you invest Rs 50,000 at 8% per annum, you will get Rs 73,466 after five years. This is if the interest is compounded once every year. If it is compounded twice a year, it goes up to Rs 74,012. The amount in PPF is compounded once every year. In NSC, it is twice.
3. See if you get any tax break.
For instance, investment in PPF, NSC and bank deposits with a minimum tenure of five years would be eligible for deduction under Section 80C. All investments under this section are eligible for a deduction up to Rs 1,00,000. But you will be taxed on the rate of interest, except for PPF which is tax-free.
To check the various fixed-return investments, read Want a fixed return?
