Where to invest your Diwali bonus

Clearing short-term loans with the bonus money before investing is a wise option.



It's that time of the year when your savings account sports a healthy balance, thanks to Diwali bonus. Would you like to simply blow this money up on clothes and crackers or make it last longer? Here are a few investment options to harvest more money.

First clear any short-term loans, such as personal loans or credit card bills, with the bonus money. Given the high interest rates that you will be currently paying on these borrowings, investing before you settle the loan may be a drain on your savings.

Safe tax havens

You may be aware that your bonus, like your salary, is taxed. So how about recouping the tax you shelled out by investing in safe tax-saving options? Take a look at the traditional option of National Savings Certificate. While this would entail a six-year lock-in, it is one of the most tax-efficient and risk-free options with an assured return. After reckoning tax savings, the interest rate at 8 per cent compounded annually translates into effective yields as high as 14.3 per cent for those in the 30 per cent tax bracket. Even those in the 10 per cent tax bracket will earn decent returns of 9.9 per cent after tax benefits and deductions.

The interest component by way of being automatically reinvested (as interest is accrued), gets deduction under Section 80C every year. Hence, only the interest earned in the final year is taxed. If you can lock in your savings for a longer period, then the humble Public Provident Fund (PPF) account can be a silent wealth builder. Consider this: If you invest Rs 50,000 now, the amount would more than treble to Rs 1.6 lakh in 15 years.

You will, however, have to keep this account alive with an investment of at least Rs 500 every year. You can invest up to Rs 70,000 a year. Regular investment in this account can work wonders, given the dual benefit of tax deduction under Section 80C if you invest every year and tax-free interest income. Added to this, you can apply for a loan against your PPF account after the end of the third financial year and can withdraw sums from the seventh financial year.

If you invest Rs 50,000 every year in the PPF, you will end up with Rs 14.7 lakh after 15 years if the current interest rate of 8 per cent prevails. Consider investing at least a part of your bonus every year in this low profile performer.

The five-year tax-saving deposits offered by banks also provide Section 80C deductions. However, the tax levied on interest makes this a less lucrative option compared with the above two. Nevertheless, the lower lock-in period and safety (deposit and savings account balances up to Rs 1 lakh are insured) make this a good option to invest your bonus.

If you do not care about saving taxes or have already exhausted the tax-saving investment limit of Rs 1 lakh, then normal bank fixed deposits are good parking grounds. Bank deposits currently offer interest rates between 9.75 per cent and 10.25 per cent for deposits of 1-3 years. Remember, though, that the post-tax interest for an investor in the 30 per cent tax bracket, will be in the range of 6.8-7.1 per cent. This opportunity may not last for very long as deposit rates have already climbed quite a bit from their lows.

Medium-risk options

If you are game for a slightly higher risk, then corporate fixed deposits and non-convertible debentures from companies with a good credit standing are ways to earn superior returns. With interest rate said to be nearing its peak, it may be a good time to lock in to 1-3-year deposits of companies such as HDFC or Sundaram Finance. Always insist on knowing the credit rating received by the company for its debt issue. While convertible debentures and fixed deposits of non-banking finance companies state their credit rating explicitly, many other firms that raise fixed deposits do not disclose it along with the application form.

Do not invest in deposits of companies if you do not possess such information or do not know the financial status of the company. As for the rating, a Triple A-rated instrument will be considered safe enough for retail investors. A double AA rated issue, although one notch below, is also acceptable.

Another option in the medium risk category are infrastructure bonds issued by infrastructure finance companies. Investments in these bonds receive tax deduction under Section 80CCF of the Income Tax Act up to Rs 20,000. They can be termed medium-risk options, as there is no guarantee for the interest or capital.

They have a lock-in of five years and a much longer maturity period.

While interest rates vary across issuers, offers with a coupon rate of 8.5 per cent, available currently, yield post-tax returns of 14 per cent. Here again, go for the Triple A-rated issues.

Liquidity

If you are not willing to lock your money and can assume more risk, there are quite a few mutual fund options. Monthly Income Plans as well as other debt-oriented funds with a wee-bit of equity exposure provide that extra bit of returns that traditional pure-debt instruments may not offer.

With a return track record of 12 to 15 per cent compounded annually over a three-year period, these funds can be redeemed any time.

They are also more tax-efficient compared with income earned on deposits. Dividends are tax-free in the hands of an investor.

While short-term capital gains, if sold within a year, are subject to your normal tax slab, long-term capital gains are taxed at 10 per cent without indexation.

We would, however, rate these are slightly risky options for two reasons: one, their exposure to equity loads them with risks typical to the equity asset class. Two, unlike deposits, there is no assurance on dividend payout or capital appreciation.

Now, go ahead and start your investments this Diwali.

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