Skip to main content

Some strategies to beat the risks associated with Debt instruments

   Many investors take it for granted that returns from debt instruments are safe and reliable. The portfolio of a risk-averse investor is dominated by fixed income instruments. While the quantum of risk could vary significantly from equity investments, debt investments aren't entirely zero risk products.


   Rising interest rates has many investors flocking to lock their surplus in fixed instruments. However, before investing your hard earned money in fixed income instruments, you must judge whether you are prepared to take on the associated risks.
   
Here are some risks associated with debt instruments:

1) Interest rate risk    

The interest rate risk is the possibility of a change in interest rates that could eat into your returns. Returns on bonds, for instance, are directly impacted by interest rate fluctuations. There exists an inverse relation between interest rates and bond prices. If the interest rates rise, bond prices usually decline. If the interest rates decline, bond prices usually increase.


   New bonds are usually issued with higher yields as interest rates increase, making the old bonds less attractive.

2) Inflation risk    

With returns usually in single digits, a spiraling inflation could chew into your returns. So, your real returns could be far less than what is apparent. With inflation gradually marching upwards, the real returns on some old fixed instruments are actually negative.


   Assume a bank promises nine percent interest on your deposit per year. If the inflation rate is currently eight percent per year, then the real returns on your investment would be merely one percent.


   While the real value of your investment will climb up by only one percent during the one year period, imagine the predicament if inflation crosses into double digits. The real returns would be negative. Tax component, if considered, could reduce the real returns further.

3) Liquidity risk    

While fixed deposits are immune to interest rate risk, they are exposed to credit and liquidity risks. Credit risk arises when borrowers are unable to make payment of interest or principal in a timely manner. Bonds carry considerable risk of default that amounts to the inability of the issuer to make further income and principal payments.


   Another associated risk to consider is the liquidity risk.


   In essence, fixed income instruments are not the guaranteed products that they appear to be. If you do not research well before investing, you could end up with peanuts in your portfolio.
   
So tips for investors in debt products:

1) Look for new avenues    

Explore beyond traditional products that are novel and promise higher returns. A wide platter of options is available in debt mutual funds that vary in terms of risk-returns, liquidity and safety.


   You can select from short term funds, money market funds, gilt funds, fixed monthly income plans and so on based on your risk profile and asset allocation strategy. Returns on short term funds are on par with fixed deposits. Factor in the exit load and other charges when assessing returns from these funds.

2) Consider laddering    

In an increasing interest rate scenario, it becomes difficult for an investor to judge the best time to lock his money in fixed deposits. What if the rates climb higher tomorrow?


   In laddering, instead of locking your entire money in one fixed deposit, break it into smaller portions and lock them in different deposits having different maturity dates. This technique helps reduce the adverse impact of rate fluctuations, increases liquidity and draws maximum returns.


   What if the rates fall? You can be glad you have locked a portion of the surplus at higher rates.

3) Fixed maturity plans    

Fixed maturity plans (FMPs) that invest in high quality bonds are a safe bet. With tenures ranging from 3-15 months, these plans hold the bonds till maturity. Hence, certainty of returns is assured in case of FMPs.

4) Rebalance periodically    

Dimensions including risk appetite, liquidity needs and age impact an investment pattern. As one grows older, the quantum of risk he is willing to take shrinks. Further, relative asset allocation between fixed returns instruments, equity, real estate and precious metals changes with time. Rebalance your portfolio periodically to regain the original asset allocation.

5) Diversify    

Build a well-diversified portfolio with a mix of both safe and high risk-returns products. Even if you are risk-averse, a small exposure to equity is not a bad idea, especially in times of high inflation.
 

Popular posts from this blog

Am you Required to E-file Tax Return?

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...
Read more

IDFC - Long term infrastructure bonds - Tranche 2

IDFC - Long term infrastructure bonds What are infrastructure bonds? In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 (" Income Tax Act ") to provide for income tax deductions for subscription to long-term infrastructure bonds and pursuant to that the Central Board of Direct Taxes passed Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010. These long term infrastructure bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly. Long term infrastructure Bonds by IDFC IDFC issued an earlier tranche of these long term infrastructure bonds on November 12, 2010. This is the second public issue of long-te...
Read more

ULIP Review: ProGrowth Super II

  If you are interested in a death cover that's just big enough, HDFC SL ProGrowth Super II is something worth a try. The beauty is it has something for everybody — you name the risk profile, the category is right up there. But do a SWOT analysis of the basket, and the gloss fades     HDFC SL ProGrowth Super II is a type-II unit-linked insurance plan ( ULIP ). Launched in September 2010, this is a small ticket-size scheme with multiple rider options and adequate death cover. It offers five investment options (funds) — one in each category of large-cap equity, mid-cap equity, balanced, debt and money market fund. COST STRUCTURE: ProGrowth Super II is reasonably priced, with the premium allocation charge lower than most others in the category. However, the scheme's mortality charge is almost 60% that of LIC mortality table for those investing early in life. This charge reduces with age. BENEFITS: Investors can choose a sum assured between 10-40 times the annualised premium...
Read more

Section 80CCD

Top SIP Funds Online   Income tax deduction under section 80CCD Under Income Tax, TaxPayers have the benefit of claiming several deductions. Out of the deduction avenues, Section 80CCD provides t axpayer deductions against investments made in specific sector s. Under Section 80CCD, an assessee is eligible to claim deductions against the contributions made to the National Pension Scheme or Atal Pension Yojana. Contributions made by an employer to National Pension Scheme are also eligible for deductions under the provisions of Section 80 CCD. In this article, we will take a look at the primary features of this section, the terms and conditions for claiming deductions, the eligibility to claim such deductions, and some of the commonly asked questions in this regard. There are two parts of Section 80CCD. Subsection 1 of this section refers to tax deductions for all assesses who are central government or state government employees, or self-employed or employed by any other employers. In...
Read more

FCCB buyback

WITH dismal share valuations causing bondholders to redeem, and not convert their foreign currency convertible bonds ( FCCBs ), which until early this year were regarded as one of the most preferred options for raising corporate debt, suddenly seem to have become millstones around the necks of issuers. It is the redemption pressure on cash-starved issuers, coupled with the need to preserve liquidity by mitigating further forex outflow, which seems to have prompted the Reserve Bank of India ( RBI ) to issue the circular permitting buyback of FCCBs. As per the circular, issuers can now buyback FCCBs under the automatic route up to any limit out of existing foreign resources or by raising fresh external commercial borrowings (ECBs,) if effected at a minimum discount of 15% on the book value. Further, FCCBs up to $50 million can be bought back with prior RBI approval out of rupee resources representing “internal accruals”, if effected at a minimum discount of 25% on the book value. I...
Read more
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