Being a depositor versus a borrower during a financial crisis

Being A Depositor Versus A Borrower During A Financial Crisis

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Being a depositor versus a borrower during a financial crisis

Posted: Thursday, November 19, 2020
By: VBS Investments |
Category: Financial Services

Whenever an economic crisis occurs, the government and the central bank are the first responders taking steps to save the economy. The government through its fiscal policy and the central banks through their monetary policy have many tools to handle the crisis and improve the situation. Any central bank’s major tool is to control the short-term interest rates in its economy. To put in simple words, every central bank tries to make saving money less attractive and spending money more attractive to change the negative trend of an economy.

Due to the Covid19 pandemic, global economies have taken a huge economic hit and India is no exception. Both the Reserve Bank of India and the central government have come forward with multiple strategies to tackle the health and wealth crisis that our country is experiencing. The RBI has cut borrowing rates to a two-decade low level to 4.40%

Following this move of the RBI, most of the banks and the central government have slashed the interest rates on the fixed deposits, PPF, Post Office Schemes to multi-year lows. These moves again make it very difficult for investors who are dependent on regular income and stability in their portfolios to match up to inflation in the short and medium-term (if this crisis continues).

On the other hand, it becomes easier for businesses and other government entities to borrow money at a lower cost and deploy that money to increase economic activity.

How to choose the right income-generating investment / deposit?

For us, the rate of return is definitely the king of metrics when it comes to choosing an income-generating investment. Most of the time there are other key aspects to look for and avoid various types of traps in income-generating investments.

There are three key factors that we look at to compare Income-generating investments provided the rate of return is relatively similar.

Security – How secure is our investment and what are the chances of it losing value at any given point of time? Fixed deposits are not always 100% secure as we have seen from the recent PMC Bank scam. Government-issued bonds are generally considered the most secure income-generating investments.

Liquidity – How liquid is our money and whether any penalties are levied if we withdraw our money prematurely. Most of the income-generating insurance plans, PPF and Post Office Schemes have very less liquidity. Debt mutual funds and savings account cash balances have relatively the highest level of liquidity in income-generating investments.

Flexibility – How flexible are my investments to the changes in the economy and the actions taken by RBI or central government? Many investments do not give us options to be flexible and manage our portfolio to tackle inflation or monetary policy actions. Bonds issued by governments and companies have a high degree of flexibility compared to PPF or Post Office Schemes.

Debt Mutual Funds – A perfect tool for prudent income generation

This category of mutual funds fulfils all the discussed metrics successfully making it a great income generator for investors.

There are various categories of debt mutual funds that are classified based on the issuer (government, municipality, bank or corporation) and the duration of maturity left in the bonds that they hold (less than 1-year, short term, medium term or long term).

With the recent budget announcement of removing a dividend distribution tax, it makes debt mutual funds a great investment for retired individuals for retirement planning to avoid paying a lot of income tax on their income.

We highly recommend a mixture of Liquid, Banking & PSU Debt, and Corporate Bond mutual funds for most of the portfolios. The proportional allocation to these categories depends on the individual investor profile.

If you are still looking for clarity on this then you can contact a mutual fund advisor and clear your queries.

A brief comparison of various income-generating investments

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