Thursday, June 3, 2010

Company Fixed Deposits - Due Diligence

Company Fixed Deposits have become popular source of getting fixed returns since the bank interest rates are way down. Returns from company fixed deposits are hovering around 12% whereas the bank interest rates are still hovering around 7%.

We also recommend few company fixed deposits, but we also want to inform the investors regarding benefits as well as warn investors regarding the pitfalls.

Company fixed deposits are unsecured. In case of bank fixed deposits, the Deposit Insurance and Credit Guarantee Corporation of India guarantees repayment of Rs 1 lakh in case of default. There is no such guarantee offered in company deposits and the safety of your deposit depends on the financial position of the company. So, as a depositor, you have no lien on any asset of the company, in case it goes into financial difficulties and is wound up. Your turn to get your money back would come only when secured lenders have been paid. So do not invest in unknown companies.

Unless you need income regularly, you should prefer cumulative schemes to regular income options since the interest earned automatically gets reinvested at the same coupon rate, resulting in better yields.

The risk involved while investing in smaller companies is higher. You can check with distributors or with friends about the credentials of the promoters and their past track record. Opt for companies that pay dividends and are profit making. Avoid loss-making companies or those who do not pay dividends. If a company has made a one-off exceptional loss in a particular year, but has a good parentage and past track record, you could consider it.

For NBFCs, RBI has made it mandatory to have an ‘A’ rating to be eligible to accept public deposits. Investors should go only for AAA or AA-rated schemes. Go for shorter tenures such as 1-3 years. This way, you can keep a watch on the company’s rating and servicing, and also have your money back in case of an emergency. Watch out for any adverse news on the company you have invested in and take necessary action if need be.

Compared to mutual funds or bank fixed deposits, company fixed deposits are rather illiquid. In most cases, premature withdrawal is not allowed before completion of three months and after 3 months there is a penalty clause which is pretty high compared to bank deposits.

For those staying in non-metros, in case the company’s banker does not have an account in their respective city, they would have to get a demand draft (DD) issued at a location where the company head office is located. Similarly, when the company pays back the principal amount, the cheque may take time to clear.

FDs are not listed and non-transferable. Interest income from fixed deposits is taxable. So if you are in the highest tax bracket, weigh your options accordingly. If there is a probability, you may need the money before a year, it is beset not to park it in company fixed deposits.

We would suggest depending on an investor’s risk profile, he could consider putting 10-20% of his or her investments in company fixed deposits. While opting for company deposits, diversify your risk by spreading your deposit over a large number of companies engaged in different industries.


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