Company FDs come with high returns

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Traditional devotees of fixed deposits (FDs) are taking a hard look at company deposits these days. For obvious reasons, though. Consider this: the State bank of India (SBI) is offering 9.25% on a three-year fixed deposit, while companies like Unitech, Plethico Pharma, Kolte Patil Developers, among others, are offering 12% per year on their FDs with similar terms.

However, investment experts advise caution. They say investors should first understand the risks involved in investing money in a company deposit before putting money on such schemes. Do not blindly get into a company deposit just because it offers higher interest rates. Be sure that it meets your needs.

Why company offer high rates?
One can understand the compulsions of FD customers, considered conservative and risk averse but looking to earn a few percentages extra when the inflation is eating into their purchasing power. However, the question you need to ask is why the company is paying you the extra returns.

Take a look at the fixed income space - the investment avenue for conservative investors. Bank FDs offer 8% to 9% at the moment. Fixed maturity plans (FMPs) from mutual funds, which are almost similar to FDs, offer about 9% to 10%.

Then you have reputed companies like Godrej Industries offering you a mere 8% or so per annum on their FDs. And HDFC, which offer 9.75% for a 33-month deposit. On the other end of the spectrum, you have companies offering as much as 12% for a three-year deposit. What explains such a large difference between rates? The answer is simple: the company offering you the higher returns is rewarding you for the extra risk you are taking.

Risk? Yes, these deposits are a little more risky than a bank FD or mutual fund schemes investing in a debt portfolio because you have nothing but the financial strength and goodwill of the company to assure you timely payment of interest as well as the repayment of capital.

In short, the company with strong financials will pay less and the weaker ones would be forced to offer a little more to compensate you for the extra risk you are taking. Don't ignore this crucial aspect in your hot search for higher returns.

Check Fundamentals of the Company
Before investing in a company fixed deposit, do your due diligence. Find out from your financial advisor or distributor about the past credentials of the company, its promoters and their past record. Check whether the company has been prompt in dispatching interest warrants and repayment proceeds.

In case of a listed company, you could take a look at its financial results before making an investment decision. If the company has been reporting profits and has a continuous dividend paying track record, your money is likely to be safe.

That is why experts consider companies like HDFC, Mahindra Finance or LIC Housing safe for fixed deposit investors. You can also look at the ratings given for the deposits. Financial experts say investors should go only for AAA- or AA-rated schemes. Avoid sectors like real estate, where there is too much adverse noise around currently.

"Many a time, even reputed companies face temporary cash flow problems and, hence, raise fixed deposits. A case in point is of Tata Motors, which offered fixed deposits in early 2009, at rates of 11% per annum, which was considered high at that point of time.
However, as an investor, you need to be a bit wary if a company is offering interest rates much higher than the rates prevailing in the market and do proper research before investing.

There have been instances in the past where companies have entered the market, promised high returns to investors and then just disappeared.

While several investors lost their investments in CRB Capital Markets, companies like Morepen Laboratories ended up giving equity shares to investors holding fixed deposits.

Remember that while 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, company deposits offer no such guarantee.

The safety of the fixed deposit depends on the financial position of the company. That is why you should be careful while selecting company fixed deposits.

The Tax implications
Remember that interest income from company deposits is taxable. So, for those in the high interest bracket, the post-tax returns may not be that profitable. However, for retired individuals or those in the 10% tax bracket, the returns could be very attractive. Financial planners recommend diversification and sticking to the asset allocation plan even while investing in company deposits.

And if you are retired and unwilling to take any risk, your money should be put in AAA- or AA-rated companies.

It would not be worthwhile taking risk for the extra 1% to 2% from unrated companies. "Ignore all the unrated companies and choose companies with the ratings of AA or higher.
Unless you need income regularly, you can opt for the cumulative schemes to regular income options since the interest earned automatically gets reinvested at the same coupon rate, giving you higher yields in the process.