Investors must follow a 3-step process before making their choice
Should I invest in this covered bond? Should I opt for the small cap AIF offered by my relationship manager?
How about this covered bond sold on a new platform offering 11%? Faced with these questions about new products floating around in the market, our question to our investors is: how many investment products do you really need?
If you’re expecting me to put a number, saying 3, 5, or 10 products, that’s not what I’m suggesting. It’s just a question of whether you need a particular product for your specific situation and your investment schedule. This can be done in three steps.
The three stages
The first is to determine if you need regular income from your investment or if you need to grow your money or just want to preserve your capital. Second, if you set a time limit for each of your requirements, it will help more in filtering products. For example, you might decide that you want your money to grow, but need access to it after 10 years. Or, you could say you need to generate income from a certain amount for the next 20 years, and so on. These requirements can be easily identified.
But, here is the third thing. And this is where many of you may be wrong. It’s about mapping the right product for the right period. For example, many of you want your stock fund to produce returns of 12% every year and make a profit for your expenses. It just doesn’t work because a mutual fund is not a fixed income product. On the other hand, you lock in a cumulative bank FD at 6%, for growth, at a time when interest rates are low. So here you expect a long-term product to provide stable short-term returns and you still want a stable but low-returning product to provide you with long-term growth. See the mix?
Using the general rules above, let’s take a look at the regulated products on the market and how to use them, and if you need them.
Take simple postal schemes which may not offer high returns (other than the savings scheme for the elderly) but which will help to preserve capital as they are guaranteed by the state. And, above all, there is certainty in their returns. But not all guaranteed products can generate income.
For example, if you contribute to PPF or EPF or special products such as Sukanya Samriddhi, you should know that they are for growth, long term. But growth there is less than for more aggressive products such as equities. If you have the time, you should ideally combine these products with some equity exposure to achieve higher returns for your portfolio.
Bank DFs also fall into this “preserving and giving income” category. Although it is not 100% secure, the ₹5 lakh deposit insurance will give you some protection. Bank FDs act as good income-generating products when you lock in when rates are high. And at high rates, they can also be locked in for 3-5 years under the cumulative option. It can also make it a growth product.
When you have a shorter time frame, say 1-2 years, products like FDs or very short-term mutual funds are much safer bets than going for stocks or mutual funds. stocks, because you can lose money with them.
Here, the interest rate should be less of a factor and security should be more important because you don’t have time to take risks in short periods.
The lesser-known government bonds (G-Secs) and government development loan bonds (SDLs) offered on the RBI Retail Direct auction platform can also be excellent long-term revenue generators, especially in a period of rising rates. These may even be better substitutes for retirement products on the market which pay much less and are also taxable.
But at the same time, if you’re entering these G-Secs or SDLs when you don’t need income and simply to diversify your stock portfolio, then they may not be good options for two reasons: First, there is only one interest payment option and you will lose on compounding unless you diligently reinvest the interest.
Second, they are fully taxable and therefore not suitable for high income earners. This is where indirect products like debt mutual funds and passive debt ETFs help you invest more effectively if you don’t need income. With no payouts (under the growth option) and better tax efficiency (indexing benefit), they can be great options for those who need diversification without any income requirement. This is an example of how you can avoid certain products, even if they are good, if they do not meet your needs.
If you have a large corpus, services like PMS may be fine if you don’t have the time to manage your own stock portfolio. But should we also add an alternative investment fund (AIF)? Not really. And if your corpus isn’t large, mutual funds can become the core of your portfolio for both short-term and long-term investment needs.
Two other rules that will be useful to you are whether the product gives you liquidity and whether you understand the product. Covered bonds, market-linked debentures, and other fancy bond options may offer more than FDs for higher risk. But do you understand them? Can you liquidate them at any time? Otherwise, you can eliminate them from your choices.
(The author is co-founder, Primeinvestor.in)