24. Think before investing in Company FDs

Those who swear by fixed deposit (FD) have never had it so good. The rates offered by banks are high. Now, they have even better news from companies. There are around 100 companies offering FD schemes currently, and most of them offer at least 1% to 4% more than bank FDs. A three-year FD from Mahindra Finance, for example, gives 10.5%, while one from Jaiprakash Associates offers 12.50%. 

Compared with this, the State Bank of India and HDFC Bank offer 9.25% and 8.5%, respectively, for a three-year FD. You don't need to be an investment wizard to figure out that the rates offered by the companies are the best you can pocket and you should park some money in their FD schemes. But, don't commit the mistake of equating a company FD with a bank FD, say experts. This is because bank deposits are covered by a guarantee from the Deposit Insurance and Credit Guarantee Corporation of India, which assures repayment of Rs 1 lakh in case of default by a bank, but there is no such guarantee for company deposits. The safety of the FD rests firmly on the financial position of the company. That is why you have to be extra careful while choosing and investing your money in a company FD. "When investing in company deposits, do not get lured by high interest rates. Check the past track record and financial position of a company before committing your money," says Anup Bhaiya, MD and CEO, Money Honey Financial Services. 

Do A Thorough Check: Before putting money in a company's FD, try to get a rough idea about the company and its activities. "Go for listed companies as there is more information in the public domain about them," says Anup Bhaiya. The next thing you could do is check on the ratings for the FDs. "Go for companies which have an AAA or AA rating (for their deposit schemes)," says Trilok Mishra, a Mumbai-based financial planner. Check the promoter's background and financials of the company. If a company has a long history and is making consistent profits and paying dividends – HDFC and Mahindra Finance, for example, then your money in its schemes will be in safe hands. Both HDFC and Mahindra Finance have a sound past track record. 

This, along with their strong financial performance and strong parentage, makes them a good bet in the company deposit space. If the financial performance of a company has been erratic, and the promoters are not well known, you should think twice before investing in its schemes. A case in point is Morepen Laboratories. The FD holders of the company were left high and dry without any payments. In the end, as per a scheme of arrangement and compromise with deposit holders, the company gave equity shares to fixed deposit holders. You don't want to face such a situation, espe-cially if you are a retired person living on interest income from safe investment avenues. In the current scenario, you should avoid putting money in real estate companies, as most companies in the sector have taken huge hit due to the high interest rates and slump in the economy. "Even in the recent past, some real estate companies have been delaying repayment," says Shankar S, a certified financial planner with Credo Capital.  

Rates High? Check Why: Whenever you come across a company paying higher interest rates, try to find out why the rates are so high. Put simply, a company should have some reason to pay a higher interest than the prevailing market rate to depositors. Most often, you would find out that the company is paying a high rate because it is in some financial trouble and the higher rate is a way to compensate investors for taking the high risk of putting money in its scheme. If you know how to ask the question, you would get the answers from distributors and financial advisors. If you are convinced with the reply, you can put money in the FD. Otherwise, look elsewhere. 

Illiquid And Taxable: If the money you have is for use in an emergency, then company FD may not be the best investment option. If you have a bank FD, then in an emergency, all you need to do is walk across to your bank with the FD receipt and you can get your money back with no difficulty. Sure, there may be some penalties for breaking the FD, but you get access to the funds to be used for the emergency. But, a company FD cannot be redeemed so easily. Typically, these FDs can't be broken before six months from the date of investment. If you break it even after six months, you would get 2% lower than the promised rate. Also, it may take aminimum of three to five days to get the money back. Also, remember that interest income from company FDs is taxable. On this front, they are similar to bank FDs. It is always better to calculate the post-tax returns from an FD. For example, if a company pays 12% on its FD, your effective return will be 8.29% if you are in the highest tax bracket. However, if you are retired or in the lower tax slab or not liable to pay tax on your income, the returns could be attractive. 

Investing Finally: Experts advise against going overboard on company FDs. "You can invest up to 10% to 12% of your fixed income portfolio in company fixed deposits," says Shankar S. If your fixed income portfolio is worth Rs 50 lakh, for example, then Rs 5-6 lakh could be invested in company fixed deposits. It would be better to spread this amount across at least four to five companies. If you are retired and depend on interest income to meet your day-to-day expenses or your monthly liabilities, the money should go into only AAA or AA-rated companies. It would not be worthwhile to chase an extra 1% to 3% return at the cost of safety. Finally, opt for cumulative schemes to maximise your returns, as the interest earned would be automatically reinvested at the same coupon rates, which will generate better yield.