Publication: Business Standard, New Delhi, Date: June 07,2009
Don’t get carried away by just the interest rate on offer when investing in company fixed deposits
Company fixed deposits (FD)have been back in vogue for the past couple of months. These range from the likes of the revered Tata Group to numerous non-banking financial companies and private companies. The biggest attraction in company FDs is the higher interest rate. Besides, there are other benefits such as premature withdrawals, TDS benefits and the choice of some reputed companies as well.
So, should one jump for a company FD to earn that higher 2-4 per cent return? Here are a few things you must check before a plunge:
INTEREST RATE AND REPUTATION
A solid company in the toughest of environment will pay in the range of 11-12 per cent, depending on the tenure of the deposit. You can get high interest rates from certain companies but make sure you know who the promoters are, what the company does and try to get a sense of its financial situation. Understanding the financials could be a complex activity and, hence, reputation and integrity of the promoters and management team must be sound. As with Tatas and HDFC. This is of utmost importance, as this deposit is unsecured and there have been numerous instances of siphoning of funds, closing of businesses and other risks.
A very high profile case in this area was of
Nagarjuna Finance and Nimesh Kampani, the non-executive director of the company in 1999. He resigned from the company in 1999, but still faces arrest, as Nagarjuna Finance defaulted on a payment of Rs 100 crore worth of FDs.
Company FDs are exposed to credit risk and so, your first focus should not be on returns, but on the repayment capability and reputation of the company. Check the past record of repayments. If this is the maiden FD, check repayments of other group companies, if any. Do not invest if there is even a single default.
Understand whether the interest rate on offer is compound or simple interest. The difference in returns can be high, based on this one simple parameter and the frequency of compounding. For example, Company A offers a 4-year deposit at the rate of 10 per cent. Compounded quarterly, it will offer a higher return than an FD with a simple interest of 11 per cent, as well as higher than one with a 10 per cent rate, but compounded six-monthly.
PREMATURE EXIT
This clause is again very important and make sure you understand this properly. You must invest money which you do not need for the tenure of the FD. But should you have an emergency, you must know the exit options. Most
FDs have an exit option with either a loss of interest or a penalty of two per cent for very early exits. However, if you exit later during the FD’s tenure, chances are there might be no penalty.
TENURE
Normally, the tenures for most FDs are in the range of 12-60 months. A higher tenure normally means a higher interest rate but this does not mean you should opt for the highest tenure. Understand the interest rates in the overall economy. And, if rates are low, opt for the lowest tenure; if rates are high , then you could lock in for the highest tenure.
FIRMS TO AVOID
There are companies whose losses increase every year because of various reasons. Avoid such FDs. Besides this, there are private limited companies. There is not much information available on them and if they have questionable balance sheets and are unwilling to disclose financial information, it’s best to avoid them. Also avoid companies which offer exorbitant interest and have poor cash flows.
Essentially, you are getting a higher rate of return for the additional risk you are taking. Though the regulations are now tighter and promoters could be issued arrest warrants in cases of default, it is better to be prudent in every financial matter. So, look beyond returns and have moderate expectations, as protection of principal is equally paramount when it comes to Company Fixed Deposits.
The writer Amar Pandit is director, My Financial Advisor
To read the original article click here