Skip to main content

Financial Planning: Choosing the right debt option

You may not be always right with debt, as some products require timing just like equity

While debt has always had its relevance for investors, its performance in the last one year has sent many rushing for it. Equity's under-performance in the last one year has only further made its case stronger with the equity market's weakness wiping out a few years' good performance at one go. While debt gives the comfort of capital safety and assured returns, not all debt options are safe in the real sense. In fact, debt can be a negative earner in a real sense if the choice of product is wrong. Hence, choosing the right debt product is as important as choosing the right stock, and in some cases, could be tougher too.

Interestingly, the challenge for many is when to allocate for debt rather than how to choose it. While the bad performance of equity automatically forces everyone to debt, it need not be the case if the investor resorts to asset allocation. If you go by the principles of financial planning, you would find that debt is an integral component for all categories of investors though the percentage of allocation may vary depending on the age and needs of the investor. For instance, young investors with limited sources of income but staring at financial commitments on a monthly or annual basis may not have the liberty to dabble with equity even if age were to be on their side.

For most other investors, debt is a necessity because of a number of factors such as protection of profits, and capital or asset allocation. Such investors probably have the luxury of altering the ratio towards debt, depending on the economic environment.

For instance, in the last 12 months, many high net wroth individuals preferred to stick to debt rather than go with equity because of the uncertain economic environment. Interestingly, a number of investors from this community began looking at the debt option way back in December 2007 when the equity indices were still on a rampage. The argument of these investors was that after the bull run for 3-4 years, investors need to turn to debt to protect profits. For some, the rising inflation and interest rates were other indicators for shifting the portfolio into debt.

In fact, during a conference in mid-2007, a fund manager of a leading insurance company commented that while investors were chasing equity, his fund was increasing its allocation towards debt and particularly in products like gilt and income funds. The performance of both these products is visible for all and unfortunately, even at current levels, the rush has continued for debt.

Those who are looking at debt for higher returns from the portfolio can look at products like gilt or income funds only with an investment horizon of 12-15 months as the returns from these schemes are likely to taper off once the rate cuts are completed. On the contrary, long-term investors can look at floaters or assured return products such as fixed deposits from companies, which offer double-digit returns. However, while parking funds in deposits, you need to take into account the tax angle as it would lower the effective yield.

Popular posts from this blog

Mutual Fund MIPs can give better returns than Post Office MIS

Post Office MIS vs  Mutual Fund MIPs   Post office Monthly Income Scheme has for long been a favourite with investors who want regular monthly income from their investments. They offer risk free 8.5% returns and are especially preferred by conservative investors, like retirees who need regular monthly income from their investments. However, top performing mutual fund monthly income plans (MIPs) have beaten Post Office Monthly Income Scheme (MIS), in terms of annualized returns over the last 5 years, by investing a small part of the corpus in equities which can give higher returns than fixed income investments. The value proposition of the mutual fund aggressive MIPs is that, the interest from debt investment is supplemented by an additional boost to equity returns. Please see the chart below for five year annualized returns from Post office MIS and top performing mutual fund MIPs, monthly d...

All about "Derivatives"

What are derivatives? Derivatives are financial instruments, which as the name suggests, derive their value from another asset — called the underlying. What are the typical underlying assets? Any asset, whose price is dynamic, probably has a derivative contract today. The most popular ones being stocks, indices, precious metals, commodities, agro products, currencies, etc. Why were they invented? In an increasingly dynamic world, prices of virtually all assets keep changing, thereby exposing participants to price risks. Hence, derivatives were invented to negate these price fluctuations. For example, a wheat farmer expects to sell his crop at the current price of Rs 10/kg and make profits of Rs 2/kg. But, by the time his crop is ready, the price of wheat may have gone down to Rs 5/kg, making him sell his crop at a loss of Rs 3/kg. In order to avoid this, he may enter into a forward contract, agreeing to sell wheat at Rs 10/ kg, right at the outset. So, even if the price of wheat falls ...

Benefits Of Repo Rate & CRR Rate Cut On Consumers

  How Reduction In Repo Rate & CRR Affects Customers Finally  RBI announced slashing of repo rate by 25 basis points (bps ) and cash reserve ratio (CRR) by 25 bps which industry experts believe will fuel the economic growth to some extent. Although experts were expecting higher rate cut this year. This lowering of the rate cuts has taken place for the first time in nine months. Now let's see how reducing the repo rate (defined in economic term as the rate at which RBI lends money to the banks) relates to the following individuals and sectors: Banking:   Lowering of repo rate directly reduces borrowing costs of a bank. Banks in turn reduces interest rates on different types of loans such as home, auto, business etc. Similarly trimming down of CRR allows banks to unlock money for lending to the customers i.e. with 0.25 rate cut banks are estimated to lend more than INR. 17 Crores. Consumers:   Lower repo rate does not necessarily benefit existing loan borrowers but new loan se...

Zero Coupon Bonds or discount bond or deep discount bond

A ZERO-COUPON bond (also called a discount bond or deep discount bond ) is a bond bought at a price lower than its face value with the face value repaid at the time of maturity.   There is no coupon or interim payments, hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the discounted price of the bond and its par (or redemption) value. In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond matures. Zero-coupon bonds may be long or short-term investments.   Long term zero coupon maturity dates typically start at 10 years. The bonds can be held until maturity or sold on secondary bond markets.

NRI Corner: The process of remittances abroad

The process of remittances abroad, and back, is cumbersome. Here’s how you can wade through without hassles Approach The Right Place Outward remittances or the process of sending money abroad is governed by many regulations. In India, outward remittances are made mainly through banks. At the outset, you need to remember that you just cannot trust any individual or a financial firm with the responsibility of sending your money. Experts recommend that you should always try to choose a bank with an international footprint, which will make your job easier. Choose Mode Of Transfer The next step is to choose the mode of transfer. One option is to get a Foreign Currency Demand Draft ( FCDD ). This draft will be denominated in foreign currency and should be drawn in favour of the recipient/ beneficiary. The beneficiary does not necessarily need to have an account with the same bank. The other option is to send money via wire transfer. Do not be puzzled if the bank official uses the word SWIFT ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now