In times of uncertainty, debt wish can be a life saver
Times of uncertainty are times to take comfort from your best friend.
It's the same with investments. When market volatility increases, inflation raises its head, interest rates are rising and there is fear of an economic downturn, the focus of investors shifts from capital appreciation to capital preservation. This is the time investors remember their old and trusted buddy — debt investment — which is typically forgotten in good times.
In this article, we will try to understand why debt acts as a saviour in times of uncertainty and takes a back seat when the investor community is in a positive mood. We will also try to figure out when the right time to invest in debt instruments is and what are the options available with us.
What are debt instruments?
A debt instrument is an asset that pays fixed returns over time. It has a fixed maturity period after which investors can liquidate the asset and gets the principal with the remaining interest dues.
These instruments are low on risk and returns, with low-to-medium liquidity.
Investors have several categories of debt available to them:
l Fixed deposits
l Debt mutual funds
l Bonds and debentures
l Government managed savingsschemes (NSC, KVP, PPF)
Debt to the rescue
Whenever there are doubts regarding economic growth, inflation is ruling high and interest rates are rising due to monetary tightening, equity valuations tend to drop and returns on debt investments become attractive.
As such, risk-averse investors prefer to invest in debt instruments. In times of uncertainty, even those with higher risk appetite get into a capital preservation mode and reallocate funds towards debt instruments.
The best time to park your money in a debt instrument is at the peak of the interest rate cycle.
We all know that inflation is increasing day by day and the RBI is trying to tame it through monetary tightening. Interest rates have gone up slowly over the last couple of years as the RBI is tightening the monetary policy. Indeed, the central bank has increased interest rates 11 times since March 2010.
There is also uncertainty about the RBI's next move when it meets later this month for monetary review. It is expected that the RBI will increase rates further as it has not been able to contain inflation so far. Based on this assumption, we should be somewhere near the peak interest rate scenario around November.
So, investors should start planning for investment as the risk-reward ratio is going to be in favour of investors in another two months.
Choices available to investors
Their broad low-risk, low-return nature notwithstanding, debt investments vary in risk and return. Government securities and bank deposits are almost risk-free (let's ignore inflation and interest rate risk), while corporate debts are riskier.
Let's take a look at the choices available to investors.
For investors with low risk appetite and long term investment horizon
As per the new Direct Taxes Code (DTC), which is expected to be implemented from April 2012, PPF investments will continue to be governed by EEE (exempt, exempt, exempt) and not EET (exempt, exempt, taxed) rules, which means investment, accumulation and withdrawal — all three related to this investment will be tax exempt. So, investment in PPF is recommended if the DTC implements this rule from 2012. Investment in PPF also acts as a tax-saving instrument, which adds to the overall return on investment. Government securities and schemes are other options for risk-averse investors.
For investors with moderate risk appetite and short-term investment horizon
Investment in debt funds and fixed deposits is a good option for investors with a short-to-medium term investment horizon. Debt funds invest in various types of debt securities and are professionally managed. Most of the debt funds are highly liquid so money can be parked in them for a short term. Once the economic condition improves and interest rate eases, this money can be reallocated to equity portfolio. If you as an investor simply want to sit and enjoy life till normalcy in the market returns, then medium-term FDs can be a very good option for you as the return on them is attractive too.
A note on DTC
DTC is expected to take away several debt instruments available to investors for tax-saving. Investment in government managed savings schemes (NSC, etc) and infrastructure bonds for tax-saving purpose are a strict no for the time being as the upcoming DTC proposes to remove them from the categories of exempted income. Investors should wait for clarity in DTC before they invest in them for tax-saving purposes.
Times of uncertainty are times to take comfort from your best friend.
It's the same with investments. When market volatility increases, inflation raises its head, interest rates are rising and there is fear of an economic downturn, the focus of investors shifts from capital appreciation to capital preservation. This is the time investors remember their old and trusted buddy — debt investment — which is typically forgotten in good times.
In this article, we will try to understand why debt acts as a saviour in times of uncertainty and takes a back seat when the investor community is in a positive mood. We will also try to figure out when the right time to invest in debt instruments is and what are the options available with us.
What are debt instruments?
A debt instrument is an asset that pays fixed returns over time. It has a fixed maturity period after which investors can liquidate the asset and gets the principal with the remaining interest dues.
These instruments are low on risk and returns, with low-to-medium liquidity.
Investors have several categories of debt available to them:
l Fixed deposits
l Debt mutual funds
l Bonds and debentures
l Government managed savingsschemes (NSC, KVP, PPF)
Debt to the rescue
Whenever there are doubts regarding economic growth, inflation is ruling high and interest rates are rising due to monetary tightening, equity valuations tend to drop and returns on debt investments become attractive.
As such, risk-averse investors prefer to invest in debt instruments. In times of uncertainty, even those with higher risk appetite get into a capital preservation mode and reallocate funds towards debt instruments.
The best time to park your money in a debt instrument is at the peak of the interest rate cycle.
We all know that inflation is increasing day by day and the RBI is trying to tame it through monetary tightening. Interest rates have gone up slowly over the last couple of years as the RBI is tightening the monetary policy. Indeed, the central bank has increased interest rates 11 times since March 2010.
There is also uncertainty about the RBI's next move when it meets later this month for monetary review. It is expected that the RBI will increase rates further as it has not been able to contain inflation so far. Based on this assumption, we should be somewhere near the peak interest rate scenario around November.
So, investors should start planning for investment as the risk-reward ratio is going to be in favour of investors in another two months.
Choices available to investors
Their broad low-risk, low-return nature notwithstanding, debt investments vary in risk and return. Government securities and bank deposits are almost risk-free (let's ignore inflation and interest rate risk), while corporate debts are riskier.
Let's take a look at the choices available to investors.
For investors with low risk appetite and long term investment horizon
As per the new Direct Taxes Code (DTC), which is expected to be implemented from April 2012, PPF investments will continue to be governed by EEE (exempt, exempt, exempt) and not EET (exempt, exempt, taxed) rules, which means investment, accumulation and withdrawal — all three related to this investment will be tax exempt. So, investment in PPF is recommended if the DTC implements this rule from 2012. Investment in PPF also acts as a tax-saving instrument, which adds to the overall return on investment. Government securities and schemes are other options for risk-averse investors.
For investors with moderate risk appetite and short-term investment horizon
Investment in debt funds and fixed deposits is a good option for investors with a short-to-medium term investment horizon. Debt funds invest in various types of debt securities and are professionally managed. Most of the debt funds are highly liquid so money can be parked in them for a short term. Once the economic condition improves and interest rate eases, this money can be reallocated to equity portfolio. If you as an investor simply want to sit and enjoy life till normalcy in the market returns, then medium-term FDs can be a very good option for you as the return on them is attractive too.
A note on DTC
DTC is expected to take away several debt instruments available to investors for tax-saving. Investment in government managed savings schemes (NSC, etc) and infrastructure bonds for tax-saving purpose are a strict no for the time being as the upcoming DTC proposes to remove them from the categories of exempted income. Investors should wait for clarity in DTC before they invest in them for tax-saving purposes.
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