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Can small savings schemes earn me large returns?

Small savings schemes, such as PPF, NSC, KVP, Post Office Deposits, are very topical in the media these days. On the one hand, these schemes are currently popular because they offer higher rates when compared to bank deposits, as well as offer the security of your capital. On the other hand, earlier this week the Government announced that it is beginning a review of the centrally administered interest rate offered in these schemes. So what should you do if you are invested in these schemes or wanting to invest in these schemes? Read more to find out...

What are small savings schemes?
What are the advantages of small savings schemes?
What are the disadvantages?
How will a reduction in the small savings rate affect me?

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What are small savings schemes?

Small savings schemes are Government administered savings schemes where the interest earned is assured and you earn a fixed return (fixed income schemes). Some examples of these schemes are:

• Public Provident Fund (PPF)
• National Savings Certificates (NSC)
• Post Office Time Deposits
• Post Office Monthly Income Scheme
• Senior Citizens Savings Scheme
• Kisan Vikas Patra

The interest earned is decided by the Government. The interest rate on these schemes was 12% about a decade ago, but over the past few years has come down to around 8% (except for Senior Citizens Savings Scheme which offers 9%). New reports suggest that the Government is considering reducing these rates further by 0.5% to 0.75%.

What are the advantages of small savings schemes?

1. Security: Small savings schemes are backed by the Government. They are very secure with very little risk of default. Therefore, these are very desirable for those investors, such as retirees, wanting security of their capital.
2. Predictable Returns: These schemes are as close as one can get to guaranteed returns. An investor knows what return they will get at the time of investing, compared to alternatives such as mutual funds where the returns might fluctuate.

What are the disadvantages?

1. Lock-ups: You lose flexibility in having access to your money because most of these schemes require that your money is locked-up in the scheme for a minimum period of around 5 years or longer, although in some cases premature withdrawal or loans against investment might be permissible
2. Unfavourable Tax Treatment: While most of these schemes are eligible for investments to avail the annual 80C tax deduction of up to Rs. 1 lakh, the returns earned on these schemes are not tax exempt (with the exception of PPF). Compared to these schemes, mutual funds have better tax treatment over a comparable investment horizon
3. Risks of High Inflation: Because the rate of return on these schemes is fixed, investing in these schemes hurts the average investor when inflation is rising, because the returns net of inflation are low and you end up reducing the purchasing power of your money. For instance, if the after-tax returns are 6%, and inflation is at 6%, then the real return is actually 0%, which essentially leaves you where you started and does not create any wealth for you.

How will a reduction in the small savings rate affect me?

If you have invested in these schemes, there is a risk that the interest you will earn on these schemes might be reduced. This will further reduce your after-tax returns.

If this rate cut happens, it will make bank deposit products more competitive when compared to the small savings scheme, and you might be more inclined to leaving your money in bank deposit products, which are more flexible, rather than in these schemes.

If you want higher after-tax returns and would like to create wealth, you are probably better off in investing in higher yielding mutual funds, as long as you understand that such funds come with higher risk than small savings schemes.

Comments

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Manish Gupta said : 20/06/2009	this is good articile plz send me more like this articile, and how to save my money as bank scheme and how to earn more money by investing plz send soon Thanks
Raj Kumar Verma said : 18/06/2009	Thanks for uploading this type of article at this moment.Everybody is busy in making money in share market.I have found very few person who have really earned money in Share Market.Ratio is 10:1.One must remember 'Slow and steady wins the race'.