Don't look at debt during uncertain times in the equity market; make it an integral part of your portfolio. Here are a few advantages.
Most investors take debt seriously only when the going gets tough in the other asset classes. That basically implies that debt is considered an option, rather than a necessity in all circumstances. The presence of debt ensures that the overall portfolio remains adequately blended to achieve several objectives.
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For one, it allows the investor to reduce the risk element in his portfolio. Any senior citizen, who is approaching retirement and needs regular income, needs to have a significant portion of his assets in debt. This is important because such portfolios have to be low risk in nature.
For instance, when a portfolio with an equity/debt ratio of 95 per cent and 5 per cent respectively faces a 20 per cent erosion in equity and 6 per cent gain in debt will show returns of -18.7 per cent. At the same time, with a similar performance, a 65 per cent equity and 35 per cent debt portfolio will give returns of -10.9 per cent.
As it is obvious, a higher inclination towards equity can hurt the portfolio quite badly. Risk control is an integral part of the entire investment management process. Some debt options that help in lowering the risk element include Government of India bonds, small savings schemes like Public Provident Fund, National Savings Certificates and even the Senior Citizen Savings Schemes.
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Also, it adds a great deal of stability to the portfolio. No investor would like to see daily fluctuations in the portfolio. If the routes chosen are just equity and other volatile assets, it could become very difficult to get a complete overview because of large fluctuations on a regular basis.
The best way to deal with this is by having debt instruments that are not linked to everyday movements in the markets. This can include instruments like fixed deposits, small savings options, like Post Office Monthly Income Scheme and recurring deposits that retain a specific value and returns will be based on rates applicable to these instruments. The capital values of these investments don't keep changing and, hence, in terms of the overall portfolio, there is an element of stability that comes in play.
These instruments also ensure some sort of regular cash flow. When it comes to equities, returns are going to be high as long as the going is good, but when there is a drop, there is a worry because of the fact that the income can stop.
There is a need to have some debt investments present that can ensure that depending upon the rate of returns, there is some regular inflow. This will ensure that there is no cash flow problem as far as the investor is concerned and that they are able to meet their requirement of generating a regular income.
For instance, a sum of Rs 1.2 lakh invested in an instrument generating an expected return of 15 per cent a year would mean that the investor will earn Rs 18,000 a year or Rs 1,500 a month. On the other hand, a monthly income plan at 8 per cent on the same amount will give the investor Rs 800 a month, but this is assured and so there is no disruption in the cash flow.
There are options in the form of Post Office Monthly Income Scheme that provide a regular monthly income while Government of India bonds and other deposits will provide an option that will pay out the money at longer time intervals.
In many cases, there is a need to ensure that funds are available at a specific date or they might be required for specific purposes at different points of time. Achieving this might not be an easy task, when the investment is in equity or real estate or gold, but only through debt.
That is the reason it is always advised that when you are approaching any financial goal, it is best that the money is moved to debt instruments to ensure safety of the capital and returns earned.
The writer is a certified financial planner