Investors have got into a tizzy after the recent stock market crash. They have already witnessed their equity portfolio gains crumble and are on the lookout for safer investment avenues. Let us go through a few alternatives that can ensure decent gains along with safety of capital.

MF debt schemes

The bond market has seen yields drop in anticipation of an interest rate cut by the Reserve Bank of India. So, it makes sense to invest in debt schemes of mutual funds.

When one, for instance, invests in a bond with a face value of Rs 100 at an annual yield of 8 per cent, one gets an interest of Rs 8 on the bonds every year. However, if market yields drop after buying it, the bond’s price will rise to compensate for the lower yield. This means if one anticipates that interest rates will fall and invests in debt funds, he/she can get both interest payments as well as capital gains from rising bond prices.

Ideally, long-term debt funds and gilt funds should perform best, followed by short-term debt funds. One can also look at dynamic bond funds, where the fund manager tries to generate higher returns by playing the yield curve in anticipation of changing interest rates.

One should avoid floating rate debt funds as their yields drop when interest rates fall without corresponding capital appreciation. If one invests with a time horizon of less than a year, one can choose the dividend option. Growth option is preferred for investments of over a year to give the investor greater tax efficiency.

FMPs

An investor can also go for fixed maturity plans (FMPs) of mutual funds, which invest completely in debt instruments, for reasonable and tax-efficient returns.

For example, if you plan to invest Rs 1,00,000 in a bank fixed deposit for 14 months at an interest rate of 9.5 per cent per year, the annual interest would amount to Rs 11,083. If you are in the highest bracket, you will be paying tax at a rate of 30.9 per cent — amounting to Rs 3,425. It will give you a post-tax yield of only 6.56 per cent.

However, let’s assume you invest the same amount in an FMP for 14 months at an indicative yield of 8.75 per cent per annum. Opt for the growth option, under which you will have to pay long-term capital gains tax on your earnings at the rate of 20.6 per cent after indexation. If you are investing in February this year, the maturity will take place in April 2009 when you will be entitled to indexation benefits for two financial years.

Let us assume that the cost inflation index for both years would be 3.5 each. Of your total gains of Rs 10,208, only Rs 2,041 will be taxed — amounting to Rs 420 — giving you a post-tax yield of 8.39 per cent!

Other instruments

You can also consider investing in other fixed income instruments such as the government’s 8 per cent Relief Bonds, better known as RBI Bonds.

If you are a senior citizen, you can consider investing in the 9 per cent Senior Citizens Savings Scheme. However, these instruments are fully taxable. Moreover, tax is deducted at source, which can bother senior citizens who have to claim refunds if their income falls below taxable limits.

NSC, which gives 8 per cent per annum, is also an option, since investments in them as well as bank fixed deposits of five-year tenure provide tax deductions under section 80C.

The public provident fund fares slightly better, since it provides the same tax benefits and interest rates, but the advantage here is that the interest income is fully tax exempt. However, one can only invest a maximum of Rs 70,000 per year.

The post office monthly income scheme, which had fallen out of favour because of the removal of 10 per cent bonus on maturity, can be considered also, since a 5 per cent bonus on maturity has been reinstated. While this is fully taxable, the yield is higher due to monthly compounding and bonus on maturity.

(Rishi Nathany is a certified financial planner and director of Touchstone Wealth Planners Private Limited)