A recurring deposit (RD) is a terrific instrument for meeting important short-term goals. If I can claim to have some financial discipline it is because I observed my parents open RDs for meeting their short term goals ranging from paying insurance premium to my school fee. For the new generation of investors I guess the RD could be introduced as a SIP in a debt fund with a predetermined rate of return!
For important short-term goals (say, 3 years or less) a RD is a guaranteed way of saving, irrespective of ones tax bracket. It is surprising to see many ‘experts’ talk only about debt funds and ignore RDs. If I wanted to save for my sons school-joining fee I will trust only a RD. If I wanted an SLR camera, and can wait a year or more, I will probably invest in a liquid debt fund or an ‘arbitrage’ mutual fund.
The only issue with RDs is tax computation. Although banks do not deduct tax on RD interest it is entirely taxable and should be paid on an accrual basis,. That is the interest earned in each financial year should be declared for tax computation. Taxation is as per income slab. Trouble is RDs are typically compounded quarterly and the interest earned each FY is not obvious at all.
Here is a RD calculator which give you the tax liability each FY for different types of compounding (annual, half-yearly, quarterly and monthly). This allows the user to change the monthly deposit until the post-tax corpus matches with the target.
If you want to know more about annualised yield associated with a recurring deposit, check out this version:
This first appeared as a guest post in OneMint.
Here is a collection of good RD resources