Investors should follow a 3-step process before making the pick
Should I invest in this this covered bond? Should I go for the small cap AIF that my relationship manager suggested?
How about this secured bond sold on a new platform that delivers 11%? When confronted with these questions on newer products that float in the market, our question to our investors is — how many investment products do you really need?
If you’re expecting that I put a number to this, saying 3, 5 or 10 products, that’s not what I am suggesting. It is simply knowing whether you need a particular product for your specific situation and your time frame of investing. This can be done in three steps.
The three steps
The first is to decide whether you need regular income from your investment or you need your money to grow, or if you simply want to preserve your capital. Second, if you fix some time frame for each of your requirements, it will further help filter products. For example, you could decide that you wish your money to grow but need to access it after 10 years. Or, you could say you need to generate income from a certain amount for the next 20 years, and so on. These requirements can be easily identified.
But, here’s the third thing. And, this is where many of you can go wrong. It is mapping the right product for the right time frame. For example, many of you want your equity fund to deliver 12% returns every year and take some profit for your expenses. This just doesn’t work simply because a mutual fund is not a fixed income product. On the other hand, you lock into a bank cumulative FD at 6%, for growth, at a time when interest rates are low. So here you are expecting a long-term product to deliver short-term steady returns and but still want a steady but low-returning product to give you long-term growth. You see the mix up?
Mapping products
Using the above thumb rules, let’s take a look at regulated products in the market and how to use them, and whether you need them.
Take the simple, post office schemes that may not deliver high returns (other than the Senior Citizens’ Savings Scheme) but which will help preserve capital as they are sovereign guaranteed. And, importantly, there is certainty in their returns. But not all guaranteed products can generate income.
For example, if you are contributing to PPF or EPF or special products such as Sukanya Samriddhi, then you should know that they are meant for growth, for the long term. But growth here is less than it is for more aggressive products like equity. If you have the cushion of time, you should ideally mix such products with some equity exposure to get kicker returns for your portfolio.
Bank FDs also fall in this ‘preserving and giving income’ category. While safety is not 100%, the ₹5 lakh deposit insurance will ensure you are somewhat protected. Bank FDs act as good income-generating products when you lock in when rates are high. And at high rates, they can be locked in for 3-5 years as well under the cumulative option. This can make them a growth product as well.
When you have a shorter time frame, say 1-2 years, then products like FDs or very short-term mutual funds are far safer bets than going for stocks or equity funds, as you can lose money with the latter.
Here, the interest rate should be less of a factor to consider and safety must be given higher weight, as you don’t have time to take risks in short periods.
The lesser-known government bonds (G-Secs) and State development loan (SDL) bonds offered in the RBI Retail Direct platform on auction can also be great income generators for the long term, especially in a period when rates are rising. These can even be better substitutes for pension products in the market that yield far lesser and are also taxable.
Eliminate options
But at the same time, if you enter these G-Secs or SDLs when you don’t need income and merely to diversify your equity portfolio, then they may not be great options for two reasons: one, there is only an interest-payout option and you will lose out on compounding unless you diligently reinvest the interest.
Two, they are fully taxable and are, therefore, not suitable for those in the high-income bracket. This is where proxy products such as debt mutual funds and passive debt ETFs help you invest more efficiently if you don’t need income. With no payouts (under growth option) and better tax efficiency (indexation benefit), they can be great options for those who need diversification without any income requirement. This is an example of how you can avoid some products even if they are good ones, if they don’t fit your need.
If you have a large corpus, then services like PMS may fit if you don’t have time to manage your own stock portfolio. But, do you then need to add an alternative investment fund (AIF) as well? Not really. And if your corpus is not large, then mutual funds can become a core of your portfolio for short- and long-term investment needs.
Two other rules that will come in handy are whether the product gives you liquidity, and whether you understand the product. Covered bonds, market-linked debentures and other fancied bond options may deliver more than FDs for higher risk. But do you understand them? Can you liquidate them any time? If not, you can eliminate them from your choices.
(The writer is Co-founder, Primeinvestor.in)
