Do You Need DEBT In Your Portfolio?

Always remember while constructing an investment portfolio, there should be three core objectives on the investor’s mind:

1. PROTECT CAPITAL
2. BEAT INFLATION AND
3. CREATE WEALTH

While beating inflation and wealth creation are normally targeted through equity, capital protection is addressed through investing in debt.

Debt as an asset class plays a vital role in an investor’s portfolio for broadly three reasons:

Strategy & Suitable Products for Capital Protection:

When there are clear short-term goals within, say a 0–3-year period, it is better to keep it in debt instead of being exposed to riskier equity asset classes. The strategy for keeping the funds required for short term goals should address liquidity & safety of capital. Suitable products are Bank FDs, Post office TDs and ultra-short term debt funds.

Strategy & Suitable Products for Regular Cash Flow:

The need for Fixed income debt instruments arises when an individual enters the post retirement phase. Strategy for selecting a fixed income product should be based on “which debt instrument will provide highest guaranteed returns over the longest period of time in current scenario”. The suitable product range are LIC & Other Insurers Pension Plans, PSU bonds, GSec, Senior Citizen Savings Scheme etc. Opting for a combination of these instruments will address the fixed cash flow requirement for a tenure of between 5-years to a maximum of 30 – 40 years.

Strategy & Suitable Products for Risk Mitigation in Portfolio:

Risk mitigation is a key aspect of asset allocation and the need for this arises in both pre & post retirement phases. While during the post-retirement phase, the allocation towards debt is met through fixed income instruments, during the pre-retirement phase the strategy for allocation towards debt must be managed through high yielding & growth-oriented debt products with “Safety of Capital” as the priority.

In current scenario, The Employees Provident Fund (EPF), Public Provident Fund (PPF) & Sukanya Samriddhi Yojana (SSY) are high yielding products post-tax along with GSec & PSU bonds which come with Sovereign guarantee and tax benefits. Contribution to these instruments should be as per individual requirements and asset allocation mix.

Besides these considerations, one must go through the risk-reward relationship before investing in debt instruments. There are critical risks involved in debt instruments as well which must not be ignored. Read here in detail.

Higher returns always come with higher risk. And if you are ready to take risk, take it through Equity, not Debt. Focus on debt should always be RETURN OF CAPITAL and not RETURN ON CAPITAL.

Mimi Partha Sarathy
Managing Director,
Sinhasi Consultants Pvt. Ltd.

But, When To Allocate To Debt?

Managing the equity portfolio is comparatively easier than debt portfolio. Predicting the debt markets and taking the debt investment calls according to the prevailing & forthcoming macro-economic level along with respective interest rate scenario are usually difficult task. However, it becomes easier when we choose the debt products according to the objective.

1. If the objective is to park funds for short term requirements, then do it immediately regardless of any market situations. Look for bank FDs in systematically important and too-big-to-fail larger banks or ultra-short term debt funds for such goals.
2. In case you are nearing your retirement and looking for a regular cash flow or the objective is to balance the overall asset allocation, consider the market situation before investing in the suitable products. There is no point in blocking the investment for long term with lower yield. When the interest rate cycle is at the peak level and the yield is ranging from 7.5% to 8% like the current one, this is the ideal time to lock your investments. Generally, higher yield cycle continues for 6-12 months’ time before it comes down and one has enough time for the investment during this period.

Now Is The Right Time To Move from Equity To Debt!

Currently, the global as well as Indian economic conditions are not favourable for equity markets as the inflation has not cooled-off yet. The interest rate is peaking, energy prices are still high, commodity prices are still inflated, and the supply chain has not yet returned to normal. We feel, the equity market will remain volatile for another 5-6 months. Sensex being at 58K-60K, you should consider booking partial profit and allocate towards debt.