Bank time deposits is one of the most popular and preferred investment destinations of Indian households. But given the drop in interest rates of bank FDs to around 5%, investors have started looking for alternative investment options to earn slightly better returns. Financial planners have started recommending AAA-rated fixed deposits to these investors, but cautiously to be mindful of the risk. Unlike bank FDs, corporate FDs do not carry any guarantee of capital safety. AAA-rated corporate FDs like HDFC Ltd and ICICI Home Finance Ltd offer an interest rate 1-2 percentage points higher interest rate than a bank FD.
An investor should be wary of these three risks of investing in corporate FDs :
Default risk: Unlike bank FDs, corporate FDs are unsecured. These instruments do not guarantee capital protection nor interest payments. An investor may lose his money if the company faces financial distress.
Unattractive post-tax returns: Interest from corporate FDs is added to the investor's income and taxed at the rate of income tax applicable to the investor. For those in the higher tax bracket, corporate securities apps don't seem appealing.
Premature withdrawal attracts penalty: Most of the company's fixed deposits come with a three-month insurance period when the investor cannot take any amounts. Even after the retention period has expired, withdrawing before expiration means that the FD is completely closed. There is no possibility of partial withdrawal. Also, the investor will have to waive some interest if a withdrawal before the FD matures.
However, mutual fund managers believe that those who have a desirable risk profile can invest in very few selected company FDs with the highest rating.
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