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:
Before investing in debt, ask yourself the following questions:
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.
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
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.
Sorry! There are no related views on news for this company/sector.
Last time the smallcap index crossed 19k a big correction followed. Here's what makes it different this time.
In this video, I'll show you how to get started on the path to daily trading profits.
In this episode, ace trader Brijesh Bhatia talks to us about the best investments of 2021, his profitable trading system, and much more.
An Indian company founded three decades ago in a garage caught my attention...
More
Equitymaster requests your view! Post a comment on "How To Position Your Debt Portfolio for Smart Gains". Click here!
Comments are moderated by Equitymaster, in accordance with the Terms of Use, and may not appear
on this article until they have been reviewed and deemed appropriate for posting.
In the meantime, you may want to share this article with your friends!