Fixed Income – Do not invest only In Safe Options
If you allocate too much to safe debt products, your portfolio runs the risk of falling behind inflation.
Most investment portfolios are skewed in favour of debt. Investors want stable returns, even if they are low. But this `safety first' attitude can hamper long-term goals because the returns from debt instruments lag inflation. Even investors who are careful about their asset allocation can get it wrong. Very few salaried professionals take into account their Provident Fund (PF) when drawing up an asset allocation plan. The 12% of their basic pay that flows into the PF every month and a matching contribution from their employer is actually enough to take care of the debt portion of their portfolio.
What you should do:
Don't dip into your PF account before retirement. Keep it intact till the last day of work and you can build a huge corpus. If a 25-year-old starts working at a basic salary of Rs 20,000 and gets annual increments of 8%, he would have saved Rs 2.75 crore in his PF by the time he retires at 60.This also means that an individual won't need to put additional money in debt. The rest of his investible surplus can flow into equities and other lucrative investment classes.
NOT EXPLORING OTHER OPTIONS
Bank deposits and Post Office schemes are the favourite investment options when it comes to debt. But these are not very tax efficient. The entire income from fixed deposits is taxable at the normal rate. For a person in the 30% tax bracket, the post-tax returns from a fixed deposit that offers 9% is actually 6.3%.Given the prevailing inflation rate, the investor is actually losing money. Most debt instruments, including recurring deposits, NSCs, tax-saving infrastructure bonds, company fixed deposits and non-convertible debentures are also taxed similarly.
What you should do:
Factor in the post-tax yield when evaluating an instrument. Go for tax-free options like PPF or tax-free bonds. For salaried taxpayers, the Voluntary Provident Fund is a tax-free haven with no limits on investment. Though the recent budget has reduced the tax advantage for debt mutual funds, FMPs still score better than FDs if the tenure is more than three years (see table).
NOT DOING OWN RESEARCH
Though the RBI frowns upon it, banks continue to project high yields on their fixed deposits. Pamphlets from most banks usually carry two columns--one showing the interest rate and other giving the "annualised yield". The annualised yield column is calculated on the basis of quarterly compounding for the entire tenure. Though the actual yield will be slightly higher due to quarterly compounding, it will not be as high as projected by banks (see table).
What you should do:
Don't go by the yields projected by banks. Instead, look at the compounded annualised growth rate (CAGR), which is the best way to compare return rates between two financial products. This is why Sebi has made it mandatory for mutual funds to use CAGR while giving their historical returns.
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