The Global markets and consequentially Indian markets have seen great volatility in the recent past, resulting in a fall in many investors’ portfolio value. Investors with a major portion of their investments in equity, face concerns of short term liquidity at such times. So how do you beat such volatility and protect portfolio value?
Investing in debt instruments could well be the answer, as it provides the much needed steadiness to your portfolio.
What is a Debt Instrument?
Debt instruments, also known as fixed income securities, typically are fixed deposits, company bonds, government schemes and debt mutual funds. These investments are considered “safe” as they guarantee the investor the principal amount along with any interest it accrues. In other words, the returns on these investments are considered to be almost risk-free. Though debt instruments generate lower returns than equity, they have the potential to cushion one’s portfolio from adverse market reactions.
The “Debt Advantage”
Financial experts recommend a right mix of equity and debt in one’s portfolio to protect returns and reduce risks. This ideal combination of equity to debt is based on many factors such as age, risk appetite and financial goals. Debt investments offer the following advantages, giving you enough reasons to include them as an asset class in your portfolio.
- Short term liquidity
Debt instruments offer good levels of liquidity, for short term financial needs, in comparison to equity. For cash needs in the immediate future, debt investments are profitable as they provide assured returns, unlike equity which could be risky at volatile times. It is therefore recommended that, equity investments form that part of your portfolio, which you wouldn’t need, say for five years time.
- Fixed returns
Debt instruments guarantee a fixed rate of interest. Incomes from such investments are predictable unlike in equity, which is quite uncertain. If you desire a fixed stream of income from your portfolio, debt instruments could offer you the same.
- Low level of risk
Debt schemes are generally issued by government and corporate agencies. They hence carry with them a low level of risk. If you are an investor, with a low risk appetite, debt could be your ideal investment choice to suit your financial need.
Choosing Debt Instruments
The Indian capital market offers various types of fixed income securities for investors. What needs to be considered while choosing is one’s risk profile, and investment time frame. A few popular debt instruments are Government Securities or G-Secs, Bonds, Money Market Schemes (schemes with a maturity of less than a year) and Gilt funds.
These are issued by private or public companies, financial institutions or the government. In comparison to G-secs, bonds carry more risk, depending upon the creditability of the company. Bonds may further be classified as Tax saving bonds or a Regular Income Bonds. They could be an ideal investment option for salaried individuals looking for short term investment avenues with a tax saving or regular income requirement.
- Government Securities
G-Secs, issued by the Reserve Bank of India for the Government of India, have short to long term maturity period, from 1 year to 30 years. Interest is paid semi- annually. Since G-Secs are issued by the government they do not have any default risk.
- Treasury Bills
Also issued by the RBI, Treasury bills or T-bills are liquid money market instruments, for duration of 91, 182 and 364 days. There is no Tax deducted at source on Treasury Bills. Treasury Bills are available for a minimum amount of Rs. 25,000 and in multiples of Rs. 25,000 thereafter.
- Certificates of Deposits
These are issued by banks or financial institutions. They offer a higher rate of interest than a fixed deposit and have maturity periods ranging from 7 days to a year. Issued in the form of demat and promissory notes, they are available in denominations of Rs 1,00,000.
- Debt- based mutual funds
Debt mutual funds predominantly invest in government bonds, company deposits and fixed deposits. This fund aims towards providing investors a steady stream of income along with capital preservation. A debt mutual fund is recommended for investors who have a low risk appetite and seek high liquidity.
- Gilt funds
Gilt funds are mutual funds which exclusively invest in G-secs and treasury bills. Investors are exposed to a variety of government securities through these funds. Returns thus prove to be a shade better than directly investing in government securities. Gilt funds however are vulnerable to interest rate risks.
A Final Word
Debt investment is vital and should be an integral part of any portfolio. Also, various credit rating agencies rate debt instruments on the basis of reliability and returns. Investors could seek the help of such ratings to help them in their decision making process.