AYUSH BHARGAVA Financial Planner | Jul 30, 2015, 08.44 PM | Source: Moneycontrol.com
Fixed deposits cannot offer a rate of return in excess of inflation. If you are planning for a long term goal, employ of a mix of both debt and equity
It was during March – April 2015 when due to second consecutive fall in repo rate, banks started reducing fixed deposit (FD) rates and as a result, conservative investors started locking their money in FD and other debt products. Those who were looking for more returns were also seen investing into corporate FD with poor ratings. FD is one of the most popular products in India. More than half of the total financial saving in India is in the form of FD. Investment in India is not done according to the asset allocation or risk profile of an investor; it is done according to the risk profile of the product. One can often find investors searching for a product wherein savings will be safe and they can earn the maximum rate of return. This usually happens when one is not an expert with different financial products and investors with very little risk taking capacity end up making investment in fixed deposits or other fixed investment products.
Why over exposure in fixed income securities can be risky for long term goals?
Conservative investors should understand that investing only in debt products can result in over exposure in a particular asset class which will not only imbalance the portfolio but will also impact the overall return on investment. Fixed income securities are not capable of beating inflation in long term. Inflation erodes the major part of returns offered by fixed income products and this is the reason why one may not become rich or wealthy. These instruments are also not tax friendly as equity investments are. Interest earned on most of these instruments is taxable. The returns in this product are lower than equity investments in the long term and thus to achieve a particular goal a conservative investor needs to invest more as compared to an aggressive investor.
Let’s understand this with the help of an example – Suppose there are three investors with different risk profile. All of them want to accumulate Rs. 40 Lakh for their children’s graduation which is due after 15 years. They earn Rs. 40,000 per month and save Rs. 6,000 for investment purpose. Let’s see who will be able to achieve the goal.
It is clear from the above example that considering a return of 8% yearly on portfolio, conservative investor will not be able to accumulate the target amount. On the other hand an investor with a balanced view where he invests equally into equity and debt products (12% CAGR) and aggressive investor (considering 15% CAGR) will achieve goals without worrying about inflation and other issues.
Here the right asset allocation is very important. An aggressive investor cannot continue with equity all his life due to volatility factor and in the same manner a conservative investor cannot solely depend upon debt products and should consider tax liability of the product and its implication on future goals. He should consider including equity investment as a part of the portfolio which will help in beating inflation and thus maintaining a proper balance.
During accumulation phase overexposure in any asset class will always result in failure to achieve future goals. Please remember the strategy of having a fixed income focused portfolio will work during distribution phase where security is more important than other things. Even if you are retired and running a fixed income portfolio, it is better to run a portfolio comprising more tax efficient options such as tax free bonds and income funds.
Source : http://goo.gl/8q4n29