Difference between FD and RD

There are very few bank based savings options available for general consumers and the most popular amongst them are Fixed Deposits and Recurring Deposits. Today lets see the basic difference between FDs and RDs, which gives better returns and when to use what.

Why do banks ask for Deposits?

First understand why banks needs deposits. Only with the money you deposit, banks will be able to lend money to people who ask for loans. They will give loans at a higher rate of interest than the rate of interest they give for deposits. This difference between the rate of interests is what earns profits for the banks.

Fixed Deposits

When you create a Fixed Deposit account, you deposit a fixed amount of money for a fixed period of time. And the bank provides a fixed rate of interest for that period of time. The rate of interest is usually higher than savings accounts as you have been locked into that account for the term. So they are also called Term Deposits.

The minimum tenure for fixed deposits are 7 days and the maximum is usually 10 years. For terms spanning few days, the rate of interest will be very similar to Savings accounts. As you go to a year or more, the interest rate hits a peak and beyond 2 years, the rate decreases slightly.

If you plot the graph of interest rates, you would get a curve like this.
FD interest rate graph
Even though the money is locked into the bank for the term, you can withdraw the money prematurely if you agree for a slight penalty in the interest rate. The penalty is only on the interest you earn and not on the actual money you put in. So you don’t have to worry about liquidity of your money.

Recurring Deposits

When you start a Recurring Deposits (RD) account, you agree to deposit a fixed amount of money every month on a particular date and agree to withdraw it after N deposits are made. The rate of interest is also fixed when you start the account.

It is calculated on each installment you pay according to how many months it was with the bank. So if you start a 12 month deposit, the first installment will earn interest for 12 months and the last deposit will earn interest only for the last month.

RDs always has a minimum of 6 months of investment period and can go upto a maximum of 10 years usually in multiples of 3 months. After the minimum 6 months is done, you can stop the RD any time you want.

Which earns higher returns?

This brings us to the main difference between both in terms of returns earned. Lets compare a fixed deposit of Rs.1,20,000 vs a recurring deposit where you deposit Rs.10,000 every month for 12 months term.

I am using a calculator from HDFC Bank website and currently the rate of interest is 6.9%. You can put in your numbers and get your results. Calculator for FD and RD. At the end of 1 year, the FD will have a maturity of Rs.128497.00 and the RD will have a maturity of Rs.124589.00. The difference of the interest earned is almost twice in FD vs RD.

This clearly shows that FDs will always have a better return since you have deposited all the money at the beginning of the term vs monthly.

Other advantages of FDs

FDs also has other advantages. You can choose a much smaller term (like few days) than RDs (minimum 6 months). And you can also prematurely break the FD and withdraw your money.

FDs also has the advantage of quarterly or monthly payout. This is useful for senior citizens who have large deposits and would like to get back a fixed monthly income from the deposits. But the best way to “invest” in FDs is to let it compound (by default quarterly) so that even your interest earns interest over a time period.

The most important benefit I could see from FDs are the sweep-in account where you link your savings accounts with your FDs and can sweep in excess balance into FDs and back into savings account whenever you need it.

Advantages of RD

So does that mean Recurring Deposits doesn’t have any advantages? No. They are very useful for people to start getting into the practice of regularly saving every month. If you setup a RD to take away money from your salary account at the beginning of every month, you will soon get used to having lesser money in your account and naturally your expenses will come down.

In fact, investing in RDs was how I introduced the savings habit for my wife. In the beginning when she handled her finances herself, I made her to put in a RD on the 5th of every month. And naturally this built up a nice corpus of money which was useful when we needed the money.

Now since she has gotten into the habit, she has progressed into SIPs and investing in equity mutual funds for long term wealth creation. She still has an RD account to save up money for vacations.

Which brings us to the next point of saving up money for short term expenses. Some might have planned for a vacation in the next 6 months or might have marriage or educational expenses in a year or so. For salaried individuals with such tight deadlines, it is easier to start an RD account which automatically debits the account from their salary accounts. Unless you are in the top tax bracket, RDs are good enough instruments to save money.

Conclusion

Finally it comes down to what you capabilities and goals are. Whether you have a bulk money to invest in? or want to invest monthly for some short term goal. Choose the right deposit type for the right goal.

ETF vs Mutual Fund

When it comes to buying a collection of stocks, there are two different ways one can invest in – via Mutual Funds or ETFs (Exchange Traded Funds). Since both have “funds” in it’s name, what is the difference between both? And which is better for an ordinary retail investor? ETF vs Mutual Fund – it is one common question lot of beginners have while investing.

etf vs mutual fund

Mutual Fund

Wikipedia says “Mutual Fund is a professionally managed investment fund that pools money from many investors to purchase securities.” Note that I have added emphasis on the “professionally managed” part.

That means there is a fund manager who’s only job is to manage the investor’s money and purchase the best security based on what the fund’s goals are. So if you are investing in an mid-cap equity fund, the fund manager is supposed to pick a few specific mid-cap stocks from the list of thousands of stocks and put in all the money you give in it.

The job of each mutual fund is to try and beat it’s benchmark index. If you see this graph of Mirae Asset India Opportunities Fund, you can see that it’s benchmark fund is the BSE 200 and it consistently beats the index. (Note: Not a buy recommendation.)

Mutual Fund vs BSE 200 Index

Since each mutual fund has a fund manager who is actively managing the fund, he charges a small percentage of your money (typically 1%-2.5%). This is called the “expense ratio” of the fund and it is what pays everyone in the fund house – right from the fund manager to the security guy in their office.

This expense ratio is also what pays the mutual fund advisor his fees for advising you to buy a fund. So every time you do a SIP in your fund, a small percentage of your money goes to everyone involved in this fund.

The price of one unit of a fund is calculated every day called its Net Asset Value (NAV) and any money you give will fetch you an equivalent quantity of the mutual fund. Usually you can get units upto 4 decimal points.

Exchange Traded Funds (ETF)

An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. ETFs track an index like Nifty or Sensex or Gold price. A Nifty ETF will hold all the stocks in the Nifty index and will naturally be priced close to the value of the Nifty Index.

If you see this graph of Nifty BeES, you will see that there is practically no difference between the red and black lines. Similarly a Gold ETF will track the price of the gold.

nifty bees

Whenever a share is removed or added to the Nifty Index, the fund manager replicates the exact transaction and so the price of the ETF will match the Index price. The fund manager is “passively managing” your money and the expense ratio will be very very low compared to active managers.

The minimum ETF you can buy is 1 unit and you can’t get fractions of units – only multiples of 1 unit.

When are ETFs good?

Since ETFs are continuously traded in the market, the price of the ETF continuously changes depending upon the value of the index. So if you have invested in an ETF and one fine day you see that the markets are falling rapidly, you can immediately call your broker and sell some units before the market falls even further.

Compare this with mutual funds, the NAV of the fund is calculated at the end of the date based on the closing price of each stock. So if you want to buy or sell some units you have to give the order before 3PM and the order will be executed based on the NAV of the fund at the end of date. So if the market falls, you will be unable to get out of the units fast enough.

To know how your investments are doing, you just have to look at the index price of that day and you can easily know how it performed. Simple and no-frills investing.

When are Mutual Funds good?

Despite being slower to react, mutual funds does have it’s own advantages. Primary advantage being that it is actively managed. Even though you pay a little extra for the fund manager, you are giving your money to professionals who know how to play this game.

Professionals with teams who are much more intelligent and with resources to evaluate which companies are good to invest. Imagine you doing this for each of the 1000s of stocks without proper training in fundamental analysis. I would prefer to give my money to the professionals than poring over hundreds of pages of financial statements.

And since Mutual Fund managers are paid to beat the indexes you will definitely get better returns than ETFs over a longer period. And the risk of market falling a by thousands of points in a single day is very rare. The Risk-Reward ratio of the extra returns of Mutual Fund is better than ETFs.

At the end of the day it is up to you to decide whether to invest in ETFs or Mutual Funds. Personally I have invested in both ETFs and Mutual Funds. I have a few lakhs of rupees in ETFs invested over 2-3 years ago, but am still continuing my SIPs in multiple Mutual Funds.

In India at least, the equity market is still not mature enough and it is very easy for fund managers to easily beat the returns of a general index. So I would prefer to invest in Mutual Funds.

Which do you want to put your money in? Comment below about your preference and why?

Understanding Record Date vs Ex Dividend Date

In the last article, you learnt the difference between bonuses, stock splits, rights issue and buybacks. But many would be confused on the different dates related to these corporate events. And on what date should one buy to get the benefits?

There are usually 4 dates which are important related to any corporate action. Lets see an example with dividends. The same would apply for others too.

  • Dividend Declaration Date
  • Record Date
  • Ex Dividend Date
  • Dividend Payout Date

dividend dates

Dividend Declaration Date

This is the date the Board of Directors meet for the Annual General Meeting (AGM) and decide whether or not to give dividends. Though the agenda of the AGM (including the dividend) is set before itself the actual voting happen during the AGM. Once the company’s board approves the dividend issue, they decide something called as Record Date.

Record Date

Shares of companies trade every day in the market and it is hard to identify who gets a dividend and who doesn’t get a dividend. This Record Date helps the company to fix the date when to get the list of all shareholders who are eligible for dividends.

As soon as you get a share of a company, your name is recorded on the register for the company as a shareholder. If on the record date your name is present in the register, you are eligible for dividend. Usually there is a decent time difference between the dividend declaration date and record date – leaving time for investors to buy stocks for dividends.

Ex Dividend Date

Ex Dividend date is the date by which you should buy the shares. In India, stocks settlement is on T+2 basis. So if you bought a stock today, you will get the stocks in your demat account after 2 working days from day. That is the date, you name also gets recorded in the company’s register.

So if your name needs to be on the register before the Record Date, you should have bought the stock 2 working days before the Record Date. So Ex Dividend Date is always 2 days before the Record Date. If you are buying a stock for the dividend make sure to buy it before the ex dividend date. On Ex Dividend date the stock price quotes at minus the dividend per share.

So if a stock is quoting at Rs.100 on the day before Ex Dividend Date and the company declared a Rs.10 dividend per share, on ex date, the price will be subtracted by Rs.10.

This makes sure that if you bought a share on ex date or later, you are not paying extra money for the dividend that you won’t be getting. Since that money is payed out to the shareholders, and you will not be in the register by the record date, you don’t have to pay a premium.

Dividend Payout Date

This is the date on which the company pays out the dividend. This comes in at least a week or two after the record date and the payout is in the form of direct account transfer or cheques.

The same dates can be applied to other corporate actions like bonus shares or stock splits. Instead of a bonus payout or stock split payout, your demat account would automatically be credited with the new stock.

This just shows that even if you missed your chance to buy a company’s shares in time for the dividend/bonus/split, you are not at a loss. As long as you believe in the company for the long run, you can invest in it and not worry about dividends/bonus.

 

What are Bonus, stock splits, rights issue and buybacks?

There are many corporate actions that a company takes that will affect the stock. Understanding the different corporate actions is important to help you determine whether to buy or sell the stock and how that action will affect you as a stock holder.

A corporate action is initiated by the board of directors, and approved by the company’s shareholders by voting on the issue.

Bonus Issue

bonus stocks giftWhen a company gives a bonus stock to it’s shareholders, it allots extra stocks to them. They are a gift to the shareholders for trusting and investing in the company. The bonus shares are issued out of the cash reserves of the company. You basically get free shares or equity against shares that you currently hold.

They are typically allotted in fixed ratios such as 1:1, 2:1, 10:2, etc. When a company allots bonus shares in the ratio of 2:1, for each 1 share you hold, you get back 2 additional shares at no extra cost. So if you hold 100 shares of a company (current price of Rs.60) and the company issues bonus at 2:1 ratio, you will get get an extra 200 shares and the total number of shares you hold will increase to 300 shares.

Remember its only the number of shares that increase. The overall value of the investment will remain the same. After the bonus is given the price of the each share will go down by the same ratio. So the price falls from Rs.60 to Rs.20.

Rs.60*100 = Rs.20*300

Your value is the same. But you have just received free shares of the same face value.

Lets see some more examples:

Bonus Ratios and Examples
Bonus Ratio No of shares before bonus Share price before bonus Value of investment No of shares after bonus Share price after bonus Value of investment
1:1 100 Rs.50 Rs.5000 200 Rs.25 Rs.5000
2:1 100 Rs.60 Rs.6000 300 Rs.20 Rs.6000
10:2 100 Rs.100 Rs.10000 500 Rs.20 Rs.10000

Stock Split

stock splitStock Split literally means what you think it means. The stock is actually split. When a stock split happens, the number of shares held increases, the value of your investment remains the same. The only thing that gets split is the face value.

If a stock’s face value is Rs.10 and there is a 1:1 stock split, then the face value is now split into 2 (Rs.5) and for every 1 stock you hold, you will get 1 more extra stock. Since the face value is now decreased by half, the current price of the stock also falls by half. If the price previously was Rs.60, now it will be at Rs.30. So the value of your investment remains the same.

Stock Split Ratios and Examples
Split Ratio Old FV No of shares before split Share Price before split Value of Investment before split New FV No of shares after split Share Price after split Value of Investment after split
1:1 Rs.10 100 Rs.50 Rs.5000 Rs.5 200 Rs.25 Rs.5000
5:1 Rs.10 100 Rs.100 Rs.10000 Rs.2 500 Rs.20 Rs.10000

Rights Issue

This is also frequently seen in markets. Companies announce a rights issue to their existing stock holder. This is just a way to way to raise fresh capital. Instead of issuing a fresh IPO to complete strangers, the company does a rights issue to it’s existing shareholders.

The shareholders can subscribe to the rights issue, if they wish depending upon the proportion of their share holding.

For example if a company does a 1:5 rights issue, it means for every 5 shares you hold, you can subscribe to 1 additional share. The advantage here is you will be able to subscribe to the new shares at a lower price than the current market price.

But remember subscribing to all rights issue isn’t advisable even though you get shares at a discount. You should always look at the fundamentals of the company and what the company’s future plans are before infusing fresh capital into it. And remember, if the rights issue price is almost equal to the current market price, there is no use in subscribing to it.

Since fresh money is brought into the company and new equity is given to the shareholders, the price of the existing shares doesn’t get directly affected by this.

Buyback of shares

Some companies announces a buyback of shares, if it has excess cash reserves and wants to reduce it’s outstanding shares in the market. It will given announce a fixed amount for each share and shareholders can choose to give off their shares back to the company at that price.

Shares BuybackUsually the price is slightly higher than the current market price so that it provides an incentive for the shareholders to use the buyback opportunity.

Companies does buybacks for one or more of the following reasons:

  • Consolidate the promoter’s stake in the company.
  • Increase the promoter holding percentage thereby showing confidence to the other shareholders.
  • Prevent competition from taking over the company.
  • Also maybe delist the company at a later stage.

Fundamentally, these reasons show that the company is confident about itself. And this decreases the liquidity of the share and thereby increases the stock price. Another reason for the stock price increase is the market is usually efficient in matching the current price with the buyback price. So the price oscillates around the buyback price till the event actually happens.

Dividends

dividendsThese are a portion of the profits that the company gives to it’s shareholders. Many companies typically give one or more dividends per year. They are announced as a percentage of the face value of each stock. So if a stock’s face value is Rs. 10 and the company announces a dividend of 100%, you will get Rs.10 as dividend for each stock you hold.

Rs.10 * 100% = Rs.10.

There are companies which doesn’t pay dividends too. That doesn’t mean they are not good companies. They just decided that instead of paying the shareholders the profits, they decided to reinvest the profits back into the business.

Also you should note that even if a company makes a loss for a year it can decide to give dividend from the excess cash reserves it has.

Since the company has given out money it has as dividends, the stock price would also reflect the new value of the company. So if a stock is at Rs.100 which announces a dividend of Rs.10, on the date the dividend is calculated (called ex-dividend date) the stock price will drop by Rs.10 (to Rs.90). So even if you buy a stock after the ex-dividend date, you get the share of the company based on what it was valid even after subtracting the dividend.

The only advantage of dividend is it is not taxable in the hands of the shareholder(up to a limit of Rs.10 lakh since 2016). So it was a good way to take some money out of the company for the promoters.

In the next article lets see what the different dates related to these corporate actions are and buying on what date lets you enjoy the benefits.

Last minute tax savings investments

Mar 31 CalendarIf you are a salaried employee the next 1 month is when your company’s HR/Payroll department keeps bugging you for your tax savings. And many employees haven’t done any investments for tax savings for this year or haven’t completely maxed out your 80C. If you also belong to that camp, there would be some colleague or friend who would try to sell you some LIC policy or a ULIP policy. But you know that you handling your insurance and investment yourself will lead to much better returns than buying an ULIP at the last moment.

If you checked my previous article comparing ULIP vs ELSS mutual funds you see that I suggest taking a term insurance and then doing a monthly SIP into a ELSS fund. Doing a monthly SIP would protect you against the ups and downs of the market. But since you missed your opportunity to start your SIP at the beginning of the financial year, you are now stuck with buying your fund at a lump sum amount. If the markets fall down after you just bought your fund, you will be at a significant loss. But there is a solution to that too.

I am assuming that you have not done any of your 80C investments and you have 1.5 lakhs ready to be invested. If you are contributing to an EPF (Employees Provident Fund) then subtract that total amount for this year from 1.5 lakhs and likewise subtract any life insurance premium you have paid.

Step 1: Get a Term Insurance first

If you don’t have a life insurance yet and you have others who are financially dependent on you, you need a term insurance first. There are numerous websites where you can search and compare different term insurances. Two of the popular ones are Policy Bazaar and the new CoverFox. First decide on a sum assured value which needs to be at least 10-12 times your current annual income. So if your annual salary is 10 lakh, your cover should be 1.2 to 1.5 crores.

Choose whichever policy is lowest price and has a decent claim settlement ratio. You won’t need any of the fancy riders or add-ons to your policy. Buy your policy online and you will be asked numerous questions. Please fill it in accurately. You would also be asked to do a health checkup (which is mostly to detect if you are a smoker or not). After all those are done, your policy document will be emailed and also sent by post to you. Now your insurance is done so you can subtract the amount you paid as premium from the 80C 1.5 lakhs limit.

Step 2: Put remaining money into ELSS

Next is investing into an ELSS fund. There are numerous ELSS funds and it is difficult to choose a good ELSS fund these days. You should get a professional financial advisors help if you can’t choose one yourself. But if you can spend a few hours you can identify good funds yourself. Goto websites like ValueResearchOnline and search for a section called ELSS. It would have different funds that are sorted by star rating. Just ignore the star rating.

Instead check for funds which has consistently performed well and given good returns even if the market is not doing good. Those fund managers know how to really pick the right stocks to invest in even if the market is on a downtrend. You can also check what kind of companies that fund invests in and how it has performed over the past 5 years. There are also neat graphs to show how an SIP in that fund would have performed.

Now we unfortunately can’t do an SIP today as we don’t have enough months remaining in the financial calendar. But we have enough weeks remaining – and as of Monday (Jan 30), exactly 9 weeks to March 31. Lets assume that you have to invest 1.4 lakhs into ELSS dividing it by 9 weeks, you have to invest Rs.15,555 per week into the fund.

Weekly SIP
Invest your weekly amounts on the dates marked in red

I can hear you asking that there is no SIP option for weekly period.
Yes there isn’t.
Does it mean you have to login to your mutual fund website and manually invest in the fund every week?
You can do that, but No. There is an easier way.

For this week, invest the first week’s amount manually. Then in the same fund house choose a Liquid fund. Make sure that the fund has no exit charges. Put your entire money into that Liquid Fund and search for an option called STP and set it up to transfer the weekly amount from the Liquid Fund into the ELSS fund on a specific day of the week.

STP to the Rescue

STP means Systematic Transfer Plan. It is an easy way to transfer money from one fund into a different fund within the same fund house. STP allows you to transfer money weekly, fortnightly, monthly or quarterly. Once you have set it up, transfers money from the Liquid Fund into the ELSS fund (just like you would have done a monthly SIP from your bank account to the ELSS fund).

And since you are doing a weekly transfer, even if the markets fall after week 1 or 2, you will be able to capture the fall over the next weeks. And the best part is once you have set it up, you wouldn’t have to lift a finger as everything is automated. End of the March you would have invested all your 80C money into an instrument which is both tax efficient and also have protected it against the market volatility.

Don’t forget to setup an SIP per month for the right amount from April 2017 to Mar 2018 (or till any year you want to).

Remember to use this STP only if you haven’t done your full 80C savings this year. Doing your regular 80C investment via STP instead of SIP would also work, but if you forgot to put in the money in your Liquid fund your STP would stop and you wouldn’t remember to check it. Instead go for a simpler SIP as the difference between a monthly vs weekly investment wouldn’t be too much over the long run.

At least from the next financial year onwards be more regular in your investments and make sure you don’t get stuck with a bad investment at the last minute. If you have any other ideas on savings tax better with only 2 months remaining, please comment below.

PS: This is just a simple idea for people to invest at the last minute. Each person’s financial situation might be different. Please get in touch with your financial advisor (you do have one right?) or email me at srini@getricher.in for help.