Beware of these things before investing in company FDs

Flip through newspapers and you will see advertisements of company fixed deposits schemes offering mouth watering returns. Some of them even offer a jaw-dropping 13.25 percent per annum for five-year tenures.

In fact, if you see this report published in Business Standard today, you will see how some NBFC’s are offering interest rate higher than bank FDs - by as much as 175 basis points. And, if you are all set to ditch the bank fixed deposits (FD) and are thinking of increasing your debt portfolio via company fixed deposits, these are a few things to keep in mind.

[caption id=“attachment_631000” align=“alignleft” width=“380”]  Investing in company FDs give better returns but there is a much higher risk here. Moneycontrol.com[/caption]

What: Fixed deposits which you make with companies are called company fixed deposits. Many manufacturing companies, non banking finance companies (NBFCs), housing finance companies (HFCs) and government-owned companies raise money through such fixed deposits.

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Why: Company FDs give you a higher rate of return than bank fixed deposits, usually 2-3 percentage points higher. Company FDs too come in various tenors from few months to a few years just like bank FDs.

Finer details: The most important thing to keep in mind is that like any investment, higher returns come hand in hand with higher risk. So, it is important to note that these FDs are an unsecured investment, which means in case the company defaults, you cannot sell the FD and recover your investment.

The interest can either be on cumulative or non-cumulative basis, depending on the terms and conditions. Also the interest can be paid on monthly, quarterly, semi-annual or annual basis or even after the maturity. This will depend on the type of FD you invest in.

Other aspects: Investing in company FDs give better returns but there is a much higher risk here. So keeping a few things in mind before investing becomes imperative.

Risk: There is a default risk. Unlike bank FDs that come with an insurance from DICGC for up to Rs 1 lakh, company FDs have no assurance. So there is always a credit risk involved.

Tenor: If you are tempted to invest and willing to take that extra risk, invest in FDs with a lower tenor of up to one year. Longer the tenor higher the risk since forecasting the financial state of the company becomes even more difficult in the long run. Also, keep an eye on the rating of the company while being invested.

Credit Rating: Always check what is the rating reputed credit rating agencies have given to the particular paper. As a rule, never invest in company FDs that don’t come with credit rating. In fact, we would say, don’t invest in any company FDs that come with a rating lower than “AA”.

Company Financials: It is important that you invest only in reputed companies and also take a look at their financials. Don’t invest in those companies who show losses, or who have not given regular dividends to their shareholders.

Returns: Returns are undoubtedly a very tempting parameter, but if some company is offering very high returns, it is a red flag. It is better to stay away from company FDs offering more than 15 percent.

Tax: Income tax is not deducted at source for deposits up to Rs 5000 and on interest income up to Rs 5000 a financial year.

Who should invest: “If you look only from the returns point of view, people in zero to 10 percent tax bracket, will benefit the most from these. Those who fall in the higher tax bracket won’t benefit much since they will get lower post tax returns. Having said that, always remember that these instruments come with a credit default risk,” said Ranjit Dani, a certified financial planner. So, if you are looking for higher returns and don’t mind that extra risk and willing to track the company’s performance and ratings, a company FD might work for you. “Instead a bond fund would be a less riskier and you pay lesser tax as well,” said Dani.

Now that you know more about these instruments, do call your financial planners to find out more. And remember that only a small part of your portfolio should be invested in such FDs, and that too based on your individual asset allocation and risk profile.