Parking surplus funds in FDs of two-three year tenure is a good option now, given the imminent softening of deposit rates.

Striving to maximise returns on your surplus funds? Parking your surplus funds in fixed deposits of two-three years’ tenure is a good option now given the imminent softening of deposit rates.

But with the market being flooded with fixed deposit schemes floated by banks, companies and non-banking financial institutions, here are three important aspects that you may need to look into while evaluating a deposit scheme.

Credit rating agencies

Credit ratings by agencies such as CRISIL, ICRA and CARE evaluate the default risk on these instruments. Accordingly, they assign a rating to these instruments based on their assessment of the risks. While the rating symbol may vary across agencies, broadly, rating grades range from AAA (which denotes highest safety) to D (default).

In addition to alphabets, a plus or minus symbol may be added to reflect the comparative standing of the instruments with the category. For instance, a FAA+ rating denotes higher safety than a FAA rated instrument.

In addition to these, rating agencies also provide an outlook on the instrument, which largely reflects the direction of the potential rating change, if any. For instance, a negative outlook may mean higher probability of a downgrade from the current rating.

While credit rating is mandatory for non-banking institutions, it is not so for other companies. Some companies may choose not to get their instruments rated. But, it is preferable to consider credit rated instruments.

securities below investment grade

Investors should also not ignore risk while pursuing returns. There is always a trade-off between risk and return. Instruments with a higher credit risk offer higher returns. It may be prudent to avoid instruments rated below the investment grade as they may not offer adequate safety of the principal and interest. The default risk in such instruments can be moderate to very high.

Even if an issuer does not actually default, with instruments below an A rating, the probability of you not receiving your interest and principal in time may be high. For instance, we have seen delayed interest payments in an unrated FD scheme floated by a leading real estate firm. Hence, it is better to stick to instruments above investment grade to ensure timely payments and safety of the investment.

Diversify portfolio

While diversification is required in equity investments, it is recommended for debt instruments too.

Given the different risk-return potential of the FD schemes, portfolio diversification results in an optimal balance between return and safety of the investment. For instance, Dewan Housing’s Ashray deposit with an AA+ rating from CARE offers 10.75 per cent for 2 years while Sundaram Finance with the highest safety rating MAAA from ICRA offers a return of 9.5 per cent.

Apportioning your funds equally across these two schemes will help you earn higher returns than you would have had you invested entire amount in Sundaram Finance scheme.

In the process you also lower your risk compared to an option where you would have only chosen Dewan Housing.

(This article was published on August 4, 2012)
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