What to consider before investing

1. Risk – What is the chance that you will NOT get back your investment?

In fixed income products, interest rate is linked to the chance of default. Higher the chance of default, higher will be the interest. If a company is offering an FD at much higher interest than government backed small-savings, then you want to find out why? If it is because the company is likely to default, then stay away. Do not lose 100% of your money chasing an additional 1% interest rate.

2. After tax return – What will you get after paying the income-tax?

Knowing what you will get after tax is vital. You should always compare after-tax return when deciding among different products. With some products like PPF and tax-free bonds, you do not pay tax on the interest. With others like FD, you have to pay tax on the entire interest. Choosing a 9% FD over a 8% tax-free bond may look sensible choice. However, if you have to pay 30% tax, then 9% FD may effectively return only 6% as compared to 8% tax-free bond. Always know the after-tax return before investing to make the right decision.

3. Interest rate – Is it fixed or floating?

This is an important consideration if you think interest rate may change. When you invest in things like Fixed Deposits or NSC, the interest rate is fixed at the time of investment. However in other investments like PPF, interest rate can change each year. You can think of such investments as a floating-rate investment. If you think the interest rate will reduce going forward, investing in a fixed-interest product is advantageous.

4. Interest payment  – When do you get your interest?

You have to know when the interest is paid. If it is paid periodically to you, then you will not get interest on the interest and will lose the compounding effect. With products like PPF, you get an interest only at the end of the term. On the other hand, in case of tax-free bonds, you usually get interest periodically (for example, every year). In other investments like an FD, you can choose to get money either periodically or at the end of term.

5. Convenience – How easy is it to invest, monitor and redeem?

Not all products have the same level of convenience. Some like NSC, need you to physically go to the Post Office every time and in others like an FD, you can do it online. Knowing how convenient a product is before you invest can save you a lot of pain later on.

6. Liquidity – Can you close the product before the end of the term? If yes, when and how?

You may have to close an investment for various reasons. Knowing whether you can close and if yes, when and how is an important consideration. With certain products like FD, you can pre-close the FD and get back the original amount plus the interest depending on how long you held the deposit. In other cases like PPF, you cannot easily withdraw your money. Knowing when and how you can withdraw (if needed) is an important consideration.