13 Mar 2017 13:45 IST

Time your deposits right

Your returns will vary depending on the rate cycle

Interest rates have been on a free fall over the past year. While borrowers have had a lot to cheer, depositors have been handed the short end of the stick. Deposit rates have fallen by a steep 100-150 basis points over the last year, with most banks now offering just 6.5-7 per cent rate on deposits of up to five years.

As a depositor, you cannot escape the vagaries of interest rate movements. But you can still make a sizeable difference to your returns over the long run by locking in at the right time and choosing the right tenure for your deposits.

Based on a study of deposit rates over a 45- and 20-year period, here are some interesting trends that depositors can draw lessons from.

Long tenure for the long haul

It is true that your cash flow mostly decides the tenure of your deposit. For instance, if you can park your money only for two years, then you have no choice but to go for deposits with a similar tenure.

But many of us simply swear by good old bank deposits and are willing to set aside money for a very long run. For such depositors, rate cycles matter little to decide on the tenure of deposits. Locking into longer-term deposits gets you better returns, whether at the end or beginning of a rate easing cycle.

We analysed deposit rate trends since 1970-71, considering three tenure buckets — one-three years (short term), three-five years (medium term) and above five years (long term).

We have assumed re-investment of deposits at the rate prevailing at the time of each maturity.

Across both the 45- and 20-year periods, returns for investors who went in for long-term deposits turned out higher than those who stayed with short-term deposits. This was irrespective of whether money was locked in at the peak or bottom of the rate cycle.

Over a 45-year period, the annual returns worked to about 8.8-9 per cent (at the bottom of rate cycle) to over 9.5 per cent (at the peak) if you opted for medium- and long-term deposits, but for the short term, it was just 8.2-8.4 per cent.

If you invested ₹1 lakh, the difference in the final maturity amount could be as much as over ₹10 lakh (thanks to the power of compounding).

Over a 20-year period, the annual returns were 9.2-9.4 per cent for medium- and long-term deposits, while short-term deposits again managed only 8.5-8.7 per cent.

Bottomline: If you have a very long horizon, of over 7-10 years, go for longer term deposits, even now, when rates are near the bottom.

Short tenure for lower rates

For depositors not looking to park money for a very long term, rate cycles matter a lot while deciding the tenure of deposits. At the end of the rate easing cycle such as now, these depositors would be better off going with one-three year (short term) deposits rather longer tenure ones.

A look at deposit rates over the last decade or so, shows that if one had invested in short term deposits at the end of the rate easing cycle in 2004 or 2009, annual returns would have been higher at 7.6-7.8 per cent than the 6.8-7.2 per cent for medium and long term deposits.

This is because, locking into long tenure deposits at the bottom of rate cycle, could deprive you of locking into higher rates when the tide turns.

If on the other hand you lock into higher rates towards the end of the rate hike cycle, go for longer tenure deposits. This is to avoid re-investing at lower rates in a downward rate cycle.

Bottomline: If you have a five-seven year horizon, go for shorter tenure deposits now so that you don’t miss out on higher rates.

Don’t miss the bus

While rates have been heading south over the past year or two, further downside may be limited. The RBI, in its February policy, kept the policy rate unchanged and subtly indicated the near-zero possibility of further rate cuts. Rate hikes could well be on the cards over the medium term.

Be ready to hop on to the rate hike bandwagon when that happens. Locking in at higher rates can earn you higher returns over the long run.

For instance, if you put money in a five-year fixed deposit in 2009-10, when rates were near the bottom, your deposits would have been locked at 6.5-7.5 per cent (initially) and would have delivered 7.3 per cent annual return until now, if re-invested.

If, on the other hand, you invested in a five-year deposit in 2007-08, locking into higher rates of 8.5 per cent, your deposits would have clocked 8.5 per cent annual return. While this may seem simplistic, many of us are unable to make the best of higher rates, because we do not have surplus to park money at the most opportune time.

Planning your investment in fixed deposits just as your other investments can help you rake in better returns over the long run.

Bottomline: Whatever your time horizon, set aside some funds to to lock in to better rates after a year or two.

(The article first appeared in The Hindu BusinessLine.)

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