Should you add CDs and NCDs to your fixed deposit-dominated portfolio?

For decades, the plain-old bank FDs (Fixed Deposits) have been the go-to option for Indians to save money. It is a simple product - deposit your money for a fixed tenure with the bank, and the bank will then give you returns in the form of interest income at a fixed rate periodically.

These days, with policy rates at multi-year highs, the depositors too are benefiting. Most banks’ FDs are now offering attractive 7-8% for tenures ranging from 1 to 5+ years.

To make things even better is that many corporate deposits (CDs) and non convertible debentures (NCDs) are offering even higher, i.e. 8-10% rates. Given the extra returns on offer, many savers are considering whether to put money in bank FDs or go towards CDs or NCDs.

There is more to choosing between the two options than just looking at the interest rates. This may sound odd as you put money in FDs for interest only. So, what else to look for?

Please allow me to explain.

First, we need to understand how the banks and corporations decide the interest rates to offer to depositors.

Banks and many corporates (NBFCs) are allowed to raise money from depositors via deposits. And they do this to lend money forward and make a business of it.

But unlike banks, these corporations are not allowed to access comparatively cheaper forms of money via savings or current accounts. It is for this reason that corporates tend to offer interest rates which are higher than bank FD rates to attract more savers. This is the main reason. Another important one is that NBFCs also have additional credit risk built into their business models and hence, need to compensate for that as well.

So, when I said earlier, that just looking at the interest rates is not enough, it is for this reason only. Entities other than banks are generally riskier and you need to assess how much is the risk.

Easier said than done but one way to assess is to look at their credit ratings. These credit ratings help determine the creditworthiness of these entities. So those who have low ratings are riskier compared to those with higher ratings and as a result, generally offer higher rates. While high rates are definitely attractive, let’s not forget the reason why they are offering such rates (to compensate for high-risk taking from depositors’ perspective).

Another, but more difficult option is to deep dive and look at the actual finances of the company itself like its balance sheet strength, its business risks, profit & loss statements, NPAs, etc.

When it comes to the concept of capital safety, then the bank FDs have the uppermost hand. Next come secured NCDs, which are followed by NBFC and Corporate FDs.

So that said, here is how you can decide whether to invest your FD money alternatively into other deposits/NCDs or not:

• For someone who is a conservative saver or if someone has a small amount (of say just a few lakh rupees) to park, then best to stick with simple bank FDs. And it is because even if you get an additional 1-2% extra returns elsewhere, it will not generate much incremental interest income given the small FD principal.
• Also, let’s not forget that bank deposits up to ₹5 lakh have DICGC insurance cover. So, if you keep small amounts in FDs, then this will be good enough cover for you in the (rare) case if your bank itself is in trouble.
• Many people keep their emergency fund money in bank FDs. That is the right thing to do instead of trying to maximise returns on the emergency fund by putting it in other deposits. Remember that Corporates/NBFCs are riskier. And you would never like your emergency fund stuck in an NBFC/corporate deposit of a financially strained company when you need it in your own financial emergency.
• For those who have larger amounts to park, they can consider putting in 70-75% of the money in bank FDs. For higher safety, it is better to choose RBI-identified Systemically Important Banks (SIBs) or the larger banks. The remaining 25-30% can be parked in other deposits or NCDs which offer higher interest rates.
• When deciding which entity to choose for CDs/NCDs, stick with those with high reputations and those who are trusted industry names and/or have AAA or similar-high credit ratings. Don’t be tempted by small dubious entities offering very high rates.

Let me explain the above points with the help of an example. Suppose you have ₹50 lakh that you want to put in FDs. Now you also want to ensure that a small part of this, which is ₹10 lakh, is earmarked as an emergency fund. So here is how you can do it. Put ₹10 lakh in plain bank FD as emergency fund.

Of the remaining ₹40 lakh, you can put ₹25-30 lakh again in bank FDs and the remaining ₹10-15 lakh in corporate deposits or NCDs of good repute or debt funds. This is of course assuming you aren’t a person with ultra-conservative risk appetite!

If this approach is taken, then those who are comfortable with a little bit of extra-but-manageable risk-taking, then their debt portfolio returns would be better optimised than just keeping everything in banks.

Dev Ashish is a Sebi-registered investment adviser and the founder of Stable Investor