Corporate FDs are offering over 1 per cent more than bank FDs. Should you invest?

Move over the traditional bank FDs. Corporate FDs (fixed deposits) are the cool kids in school. These days, companies like Bajaj Finance and Shriram Finance are offering as much as 8.27 per cent interest rate to investors. But does that mean you should dip your feet in them? Let's find out.

The good: Higher interest rate

Corporate FDs are offering over 1 per cent more than traditional bank FDs.

The bad: Relatively riskier

Deposits up to Rs 5 lakh are insured in bank FDs. That's not the case with corporate FDs.

However, there are three ways to reduce the risk:

• Check the rating of the company offering the FD. You will find its rating in the prospectus. For your information, AAA-rated companies are the safest.
  (That said, higher-rated papers are not hundred per cent immune from defaults. DHFL is the best example of this. It was a AAA-rated company and yet it defaulted and ultimately went bankrupt. Hence, it's best to spend a little time researching about the company's management and business model. Also, keep an eye out for any negative piece of news about the company.)
• Check the financial health of the company offering the FD. Look at the sales and profit growth over the years, and debt ratios like Debt/Equity and interest coverage also indicate the debt level of the company. You can get the data in the prospectus or external websites like Value Research, Screener, etc.
  
• Check the company's repayment history. Not a single default should be tolerated.

Is there a better option?

If checking a company's rating, debt ratios or sales growth sounds daunting, there's good news: debt funds . Heck, even the research-happy investors should look at debt funds due to the following reasons:

• More diversified, less risk : Debt funds invest in 45-50 debt securities. Or even more. So, even if one of them defaults, it impacts just 3-4 per cent of your portfolio. In other words, you get the benefit of diversification (spreading your investments across multiple bonds).
  Conversely, in a corporate FD, you are putting your money in one company. God forbid if even one of them defaults.
• Comparable returns: The average annual YTM (net of expenses) of a short-duration fund is 7.23 per cent compared to a middle-of-the-road corporate FDs' 7.4 per cent. (YTM, or yield to maturity, is the estimated return if the underlying bonds are held until maturity.)

Last thought

Debt funds don't promise fixed returns, but are safer as they invest in multiple bonds - and that's what fixed-income investments should do. Their primary job is to ensure your money is safe. For higher returns in the long run, always consider equity.

Also read: Which is safer: Debt funds or FD in small finance banks?