Investing in company FDs is a high risk, high return game
Nov 18 2012 , Mumbai
Choose an instrument that carries AA or higher rating
Although the return may be high, company FDs are more risky and unsecured (not secured against a collateral), compared with bank FDs. In case a company goes kaput, you will not get your money back. Also, remember that fixed deposits of all banks (including foreign banks, regional rural banks and co-operative banks) are insured up to Rs 1 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC) against default of banks due to liquidation, cancellation of banking licence or merger. There is no such guarantee on company FDs.
Here are a few factors you should consider before investing in a company FD:
Check the financials of the company: Since, economic slowdown is affecting several companies, it is advisable to invest in reputed and strong firms. Check the credentials and financials of the company in which you are investing. A strong company that regularly pays out dividends and has no losses, would be safer than a company that offers very high interest rate but is posting regular losses. The key factors to look into would be profits, growth, capital adequacy, non-performing assets and a low debt to equity ratio.
Check the ratings: The rating of such instruments can help you make an informed choice. Says Surya Bhatia, a certified financial planner, “Choose a deposit that carries a AA or a higher rating.” Those company FDs that do not carry a rating, are riskier and have a high chance of defaulting on interest and principal repayment. But the flip side is that the returns on higher-rated FDs are considerably lower than those for lower-rated FDs.
Invest for a shorter horizon: It is advisable to minimise your risk by investing in multiple corporate deposits. Also, choose a shorter tenure of say one or two years, to reduce your risk further.
Liquidity problem: Since most company FDs do not allow premature withdrawal of your principal, you will not be able to break the FD before maturity. Also, some companies may deduct the brokerage paid to distributors from the premature withdrawal amount.
Tax deducted at source (TDS): TDS will be deducted if the interest on a company FD exceeds Rs 5,000 in a financial year. Therefore, spread your investments in multiple FDs if your interest is going to be more than Rs 5,000 from one FD. Also, calculate the post-tax return before investing.
A pursuit of higher returns from company FDs comes with risks that are not commensurate with the extra post-tax return you will get from it, compared with the slightly-lower post-tax returns from bank FDs and debt schemes of mutual funds. So, be a bit wary.