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

Mutual Fund Exit Load Changes

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 Mutual Fund Exit Load Changes AMCs don't communicate about any change in exit load directly with investors, but do update on their website   The exit load applicable to your investments is the load which existed at the time when you invested in the particular fund. Any subsequent changes in the exit load will not be applicable to your investments.   However, Asset Management Companies ( AMCs ) periodically publish addendums in the newspapers, which state any change in exit loads of specific schemes managed by them. Such changes are also posted on their websites. However, a direct communication to an investor is not made, considering the costs involved in doing so. In their own interests, investors should not only track the performance of the funds they i...
Read more

Atal Pension Yojana contribution Tax Benefit for spouse

Contributions to Atal Pension Yojana (APY) are eligible for the same tax benefits as the NPS. This means that the contributions can be claimed under Section 80CCD (1B). The current limit for Section 80CCD (1B) is   Rs   50,000, over and above the   Rs   1.5 lakh limit under Section 80C. Section 80 CCD (1) is a different one, meant to cover employers' contribution towards NPS . You cannot get tax benefit by investing in the name of your spouse under Section 80 CCD . ------------------------------ ----------------- Invest Rs 1,50,000 and Save Tax under Section 80C. Get Great Returns by Investing in Best Performing ELSS Mutual Funds Top 10 Tax Saver Mutual Funds to invest in India for 2016 Best 10 ELSS Mutual Funds in India for 2016 1. BNP Paribas Long Term Equity Fund 2. Axis Tax Saver Fund 3. Religare Tax Plan 4. DSP BlackRock Tax Saver Fund 5. Franklin India TaxShield 6. ICICI Prudential Long Term Equity Fund 7. IDFC Tax Advantage (ELSS) Fund 8. Birla Sun Life Tax Relief 96 9. ...
Read more

Birla Sun Life Mutual Fund Launches Birla Sun Life NIFTY ETF

Birla Sun Life has launched a new fund namely, Birla Sun Life Nifty ETF, an open ended exchange traded fund. The new fund will be open for subscription from 4th July to 18th July 2011, at an offer price of Rs 10 per unit. The investment objective of the scheme is to generate returns that closely correspond to the total returns of securities as represented by S&P CNX Nifty, subject to tracking errors. No exit load will be charged under the scheme. The performance of the scheme will be benchmarked against S&P CNX Nifty and will be managed by Satyabrata Mohanty.   -----------------------------------------------------------------   Also, know how to buy mutual funds online:   1) DSP BlackRock Mutual Funds: http://prajnacapital.blogspot.com/2011/05/buying-dsp-blackrock-mutual-funds.html   2) Reliance Mutual Funds: http://prajnacapital.blogspot.com/2011/06/buying-reliance-mutual-funds-online.html   3) Birla Sunlife Mutual Funds: http://prajnacapital.blogspot.com/2011/...
Read more

Mutual Fund Reivew: Birla Sun Life Asset Allocation Conservative

Birla Sun Life Asset Allocation Conservative has numbers on its side to prove its credibility… Don't be surprised to find this Fund of Funds ( FoF ) in our recommendations. It has earned its place. And despite the difference in the structure of the product, there is no arguing with the numbers.   Of the total 6 years of its existence, the fund has been among the top 10 funds in its category in four of them. Last year it put up an average show and the only year it underperformed its peers was in 2008.   One aspect to look at when investing in an FoF is the expense ratio. The expense ratio of an FoF is capped at a lower limit of 0.75 per cent (2.50% for an actively managed fund). However, the FoF not only has its own expense (though lower) but even the expense ratio of the fund it is investing into. Fortunately, the fund manager takes that into account. "Expense is one of the important criteria used for fund selection and is the main reason for our investment in BSL Ind...
Read more

Short-Term Investment Options in Mutual Funds

Mutual funds offer liquid funds and ultra short term funds in the debt category, which are suitable for short investment periods. Ultra short-term funds were earlier known as liquid plus funds. Liquid funds invest in money market instruments with a maturity of 91 days or less. However, there are no such restrictions for ultra short-term funds. Who should invest in these? These are open-ended schemes. Investors with a short investment horizon or with surplus cash and low risk appetite should look at these. These could include corporate as well as retail investors. Those interested in staying invested for less than 15 days can opt for liquid funds. Retail investors who want to remain invested for two-four months, can look at ultra short-term funds. The short duration for both liquid and ultra short-term funds shields them from any interest rate volatility.   What kind of returns do they offer? In terms of an investment period less than 15 days, these funds are comparable to a ba...
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