X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
How To Position Your Debt Portfolio for Smart Gains - Outside View by PersonalFN
 
 
How To Position Your Debt Portfolio for Smart Gains

Two years ago on Wednesday, 20th January 2010, the BSE-Sensex closed at 17,051.

On Friday 21st January 2012, the Sensex closed at 16,739.

In the last 2 years, the Sensex has effectively moved sideways and experienced range bound volatility along the way.

Long term, savvy investors have taken any dips as opportunities to buy equities both directly and via mutual funds and will wait for the markets to recover to make their gains in equity. But what about the gains to be had from debt?

In its zeal to battle soaring inflation, the Reserve Bank Of India (RBI) hiked the repo rate (the rate at which the RBI lends funds to the system) by 375 basis points since March 2010 bringing us to the peak of the interest rate cycle today. Going forward, we can expect liquidity to be slowly eased into the economy to boost growth, and when that happens debt funds can start significantly contributing to your wealth building process.

The rule with debt funds is simple. When yields fall, prices rise, and vice versa. As the RBI cuts rates and interest rates start to go down across the board, investments in debt mutual funds will start to make money as prices of these instruments go up. If your portfolio is diversified across the asset classes (equity, debt, property and gold), and the debt component of your portfolio is geared for gains, then the coming year will go very smoothly on the debt side.

There are 2 main things you need to know when considering debt investments:

  1. If a life goal is less than 3 years away, invest in debt.
    At the heart of every investment is a reason for making the investment. You have invested not just to become rich, but to use that wealth for a purpose - maybe your retirement, your child's education, purchasing another property, or any other life goal you might have. These goals will have different tenures your retirement might be farthest away, while purchasing another property might be in the next 2 years. For a short term goal i.e. less than 3 years away, exposure to equity market volatility is not advisable. For goals of these tenures, capital protection is a must, with safe returns. Debt instruments are the way to go.

  2. Diversify within debt

    Before investing in debt, ask yourself the following questions:
    1. What are your liquidity needs?
    2. What is your investment time horizon?
    3. What level of debt-related volatility can you handle with commensurate returns?
    4. What is your post tax return going to be?
If you need liquidity in your investment, a locked in product is not for you so we can rule out bank and corporate FDs. You can consider liquid and liquid plus funds, and other longer tenure debt mutual funds. If you don't need liquidity and can lock in for a period of time, consider bank and corporate FDs and high rated NCDs. Currently, highly rated corporate FDs are offering 10% p.a. interest.

If you have a very short term investment horizon, say less than 6 months, your best option is a liquid plus mutual fund. Considering that short term rates are high right now, this investment will not only meet your liquidity and time horizon needs, but will also give you a decent rate of return.

If you can handle debt-related volatility, and you have a longer investment time horizon, you can consider opting for dynamic bond funds, income funds and gilt funds. Keep in mind these investments are volatile depending on the movement in the interest rate cycle as determined by the RBI. Given the volatility, these instruments are also likely to give you the highest return among debt investments. Back in 2008 when the repo rate was dropped 13 successive times, debt and gold gave the highest returns among the asset classes. Long term gilt funds gave close to 28% annualized returns.

Consider your tax bracket for actual returns when investing in debt.
If you invest in an FD, the interest earned will be taxed as per your tax bracket. If you invest in a debt mutual fund and stay invested for more than 1 year (long term), your tax will be 10% without indexation (a benefit offered by the Government to help you account for inflation in your purchase price) and 20% with indexation. Remember, dividends of non-liquid funds are first taxed at source at 14.1625% and then become tax free in your hands.

Most commonly, you will need some mix of these instruments.
For immediate liquidity and contingency fund creation needs, opt for a strong liquid plus fund.
For fixed returns with a lock-in, opt for a highly rated corporate FD.
To play the interest rate cycle, invest in dynamic bonds funds now, and when the time is right - go for income and gilt funds.

Conclusion

Making gains from debt investments is not rocket science, especially at a time when the interest rate cycle is peaking. Now is that time. Debt funds are perfectly positioned to start contributing towards achieving your goals. Just remember, keep your liquidity needs, time horizon and taxation in mind.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

Equitymaster requests your view! Post a comment on "How To Position Your Debt Portfolio for Smart Gains". Click here!

  
 

More Views on News

The Right Financial Advisor Is Around the Corner (Outside View)

Mar 10, 2016

An opportunity to find an impeccably trustworthy and competent financial guardian is in the offing.

Why financial planning should be dull and boring (Mutual Fund Corner)

Feb 29, 2016

Most financial planners come out as whiz kids who throw around financial jargon. But financial planning can be actually easy, provided one follows a disciplined approach.

What Are E-Wallets And How To Use Them (Mutual Fund Corner)

Feb 12, 2016

PersonalFN highlights the benefits of parking a portion of your expenses in e-wallets and using them efficiently.

Is Consumption Boom Over In India? (Mutual Fund Corner)

Feb 2, 2016

Mutual funds take a bearish call on the FMCG sector. The sector has started playing out due to a combination of slower growth and expensive valuations.

How to Find a Saint Amongst Sinners? (Mutual Fund Corner)

Feb 1, 2016

Ethical practices help build long lasting relationships, and healthy long-term business relationships are often mutually rewarding. But PersonalFN is of the view that the financial services industry in India seems to have forgotten this.

More Views on News

Most Popular

A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

Aug 10, 2017

Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

Aug 10, 2017

Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

Bitcoin Continues Stellar Rise(Chart Of The Day)

Aug 10, 2017

Bitcoin hits an all-time high, is there more upside left?

5 Steps To Become Financially Independent(Outside View)

Aug 16, 2017

Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

More
 

Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS