Pick funds with higher returns than tax-free schemes alone

My parents are retired government servants and around 84 years old. They are in 30% slab of income tax (I-T). Presently, they have fixed deposits (FDs), etc., for tax savings which are taxable on maturity and the interest rates are continuously going down. In this view, they want to invest in some suitable financial scheme(s) with the following features - a)The lock-in period shall not be above one year b)The interest generated shall be exempted from tax c)During emergency, if any, it shall be possible to partly/fully break the scheme and draw the money.

While I have been told ICICI Prudential Balanced Advantage Fund with Growth option is the best, please advise on the best scheme with minimum risk factor, in this case.
-Snehmani

Be careful what you wish for. If you wish for the impossible you are bound to be either disappointed or worst, cheated. For example, your requirement for tax-free income does not make sense. Would you invest in a tax-free product that provides a return of 1% p.a. just because it is tax free? Conversely, would you give up a safe but taxable return of 10% just because it is taxable? Therefore, what you really mean is that you are looking for an investment product that provides post-tax returns that are better than bank FDs. SBI is currently providing around 6.75% interest for 3- to 10-year FDs of senior citizens. Given that taxable income of your parents is in excess of Rs 10 lakh already, the effective post-tax interest rate becomes around 4.65% (6.75% less tax).

Any investment is all about four parameters - risk, return, liquidity and operational convenience. Whenever you evaluate any investment proposal, evaluate if the return after tax is likely to be over 4.65%, and, the compromises in liquidity, risk and operational convenience for getting over 4.65% return.

ICICI Prudential Balanced Advantage fund is an excellent balanced fund that will have varying degree of exposure to equity upto a maximum of 80%. As on July 31, 2017 the unhedged equity exposure was around 41%. Any fund that has an exposure to equity is subject to price fluctuations. The dividend from the fund can only be declared from realised profits after providing for unrealised losses, if any. What this means is that the dividend is by no means guaranteed and there could be long periods during which there may be no dividends in case of a sustained downtrend in equity markets. While a balanced fund is likely to provide good returns over holding periods of five years or more, it is definitely not a good option if your parents will be dependant on the dividend to be declared by the fund. So, if you look at the four parameters above in terms of returns a balanced fund is likely to provide better returns than a bank FD (after holding for five years or more) but comes at a significantly higher risk. Liquidity is easily available (redemption within three working days of request) and partial liquidity is available. Like a bank FD, the liquidity may come at a cost and partial liquidity is easy and free. The growth scheme of this fund can be a good option for that portion of their funds that they wish to pass on to their heirs as the latter’s risk profile may be much higher than your parents themselves.

If the amounts are large enough, you can consider buying tax-free bonds from the secondary markets which will give better than 4.65% after-tax yield that you are getting on the bank FD. The only issue is that liquidity is very poor and you will have difficulty selling these bonds if you need the money in an emergency. Also, it is operationally inconvenient as you will need a stock broking account and a demat account to buy and sell these bonds.

You can also buy short-term mutual funds (MFs) or government securities MFs which may give before- tax returns equivalent to or slightly better than bank FD but the post-tax returns can be much higher than bank FD. This is without sacrificing on liquidity or operational convenience.

Please consult a fee-only investment advisor to get bias-free investment recommendations. Since a fee only investment advisor charges a fee from the client and does not make any commissions from the product provider, the chances of getting unbiased professional advice are much higher.

CA Harsh Roongta is a fee-only investment adviser. (@harshroongta)