The investors’ obsession with returns makes their debt portfolio even riskier while the fact is that a debt portfolio should always provide stability and security to your portfolio. Before getting started with the debt portfolio creation process, let’s see which investments shouldn’t be there in your debt portfolio.
Investments To Avoid In Debt Portfolio
Here’re the investments which you must avoid in your debt portfolio.
Life Insurance Policies
Life insurance policies – When the interest rates are getting reduced, you must be thinking that insurance policies aren’t so bad. These policies are at least giving me 4%-5.5% returns, that too tax-free. Nevertheless, this isn’t going to be the scenario taking the present situation into consideration. When FDs were giving 6.5% rates, insurance policies were giving returns in the range of 4%-5.5% returns. Now, if the interest rates continue to reduce, the insurance policies won’t even give 4% returns. The reason behind this is that bonus rates are declared by the companies every year. The bonus rates would also reduce with falling interest rates, which in turn will lower your returns. Barring few pension policies, all traditional insurance policies declare bonus annually and the policies returns’ depend on this bonus.
Avoid making traditional insurance policies a part of your debt portfolio.
Corporate FDs (Non-Convertible Debentures)
Those 1%-2% additional returns in corporate FDs (also known as Non-convertible debentures) can eat up your entire capital.
Let me give you an example – Suppose you want to invest 10% of your debt investments in NCD, let’s assume that 10% to be 5 Lakhs. Now, consider investing these 5 Lakhs in a Bank FD at a 7% return rate. The maturity value would be 5.35 Lakhs. Whereas if you invest the same amount in a corporate FD offering 9% returns, the maturity value would be 5.45 Lakhs.
The difference of 10,000 and assuming 30% tax on this 10,000, the net gain would be around 7,000. For this meager gain of 7,000, you could be putting your entire capital of 5 Lakhs at risk. Would you?
Because if the company defaults, you won’t get anything. Do you remember the case of DHFL? People are still struggling to get their money back.
Co-operative Banks/Small Banks FDs
Greed for earning additional 1%-2% returns can put your entire capital at risk. The most recent example is PMC bank. The insurance limits for bank deposits have been increased from 1 Lakh to 5 Lakhs. This is what people say while depositing money in Co-operative Banks/Small Banks. But do you realize the consequences if a bank actually fails? How much time will it take you to get that insurance cover of 5 Lakhs – 1 year/2 years/5 years or maybe your entire life, you never know.
Again, settle for a bit lesser returns but be safe.
Credit Risk Mutual Funds
Credit-risk mutual funds invest in low-grade securities to get higher returns. Credit-risk funds are a type of debt mutual funds where minimum investment in corporate bonds is 65% of total assets in below highest rated instruments.
Trust me, I don’t believe in even highest rated securities, the way it’s freely distributed in India. And, investing in low rated securities to get an additional 1%-2% returns is undoubtedly a big risk.
Let’s see how these credit risk mutual funds perform after this COVID-19 crisis is over.
Now coming back to the main point, how should I create my debt portfolio?
Debt Portfolio For Your Investments
Here’s a list of investments for your debt portfolio.
This’s a must-have for everybody, as a part of their debt portfolio – one of the best debt schemes with Sec. 80 C tax benefit. The entire accumulation of this fund is tax-free on retirement. Flexibility in depositing any amount between 500-1.5 Lakhs in a year is indeed an attraction. However, liquidity is less during the 15-year period.
Another major advantage is that you can keep on extending it throughout your life, with or without contribution. Most importantly, returns are a lot better than other debt instruments.
Also Read: PPF withdrawal rules
Employees Provident Fund (EPF) And Voluntary Provident Fund (VPF)
EPF is quite a decent debt investment with Section 80 C benefits and tax-free withdrawal. (If withdrawn after 5 years’ service or on retirement.)
The 12% amount contributed by both the employer and employee from the basic-salary and Dearness Allowance (DA) is called EPF. An employee can choose to go beyond the 12% limit and make additional contributions towards EPF. The additional amount contributed towards EPF is known as Voluntary provident fund (VPF). It’s only contributed by an employee and the employer doesn’t contribute anything beyond 12%, which is mandatory. You can contribute a maximum of 100% of your basic salary along with DA in VPF. Only salaried employees who’re already contributing towards EPF are allowed to contribute to VPF. The interest rates are the same as EPF.
This’s the best option in terms of returns on debt instruments. The returns are even higher than PPF.
The only problem with both PPF and EPF is immediate liquidity. But when we talk about investing for long-term goals, if the liquidity isn’t available for 5-7 years,wouldn’t it help us to save for long-term goals? And yes, you can have withdrawal from PPF and VPF after 5 years, though there’re some restrictions.
So, if you’ve Rs. 100 to invest, it’s better to invest Rs. 40-50 in PPF, EPF, and VPF as there is no credit risk in these instruments. Only interest rates risk is there.
Bank Deposits/ FDs
FDs offer guaranteed returns without any risks attached. It’s a Liquid investment as premature withdrawal is allowed although with a small penalty.
FDs offer poor returns and the interest earned is also taxable. You can park your contingency fund in Bank deposits/FDs. This can ideally be your compulsory expense for about 5-6 months including EMIs. Keeping more than 5%-7% of the portfolio in Bank Deposits will eventually pull down your investments in the long-term. Your can also convert your savings account to a linked account (sweep account). Whereby the amount in excess of a particular level will be automatically converted into a fixed deposit. And that too, without losing the facilities of a savings account.
FD is a far better option for NRIs as it’s tax-free.
Debt Mutual Funds
Although debt mutual funds offer returns comparable to FDs but they’re better in terms of tax efficiency. Also, debt mutual funds like liquid funds and ultra-short-term debt funds are highly liquid. There’re many types of debt mutual funds but it’s advisable to go for liquid funds and ultra-short-term debt funds. You can have around 30%-40% of investments in debt mutual funds.
Don’t expect higher returns from debt mutual funds. Invest in it only for tax efficiency, i.e., when your investment horizon is more than 3 years. If you want to go for higher returns, it’s better to opt for PPF and VPF.
Gold has almost zero or negative correlation with other asset classes which makes it ideal to include in the portfolio.
We can have 5-10 % of our portfolio invested in this, to diversify a bit.
We all know that the golden era of real estate has come to an end. It was very well appreciated till 2010-11. Real estate prices have skyrocketed and scope for further appreciation is now limited.
You could go for one house for self-use and avail the tax benefits as well. Anytime is the right time for this. Investment in the second house must be considered only after constructing a portfolio with more liquid assets like mutual funds. Even purchasing your first house at a young age can significantly impact other financial goals of yours.
It’s better to avoid making it part of your debt portfolio unless you’ve a surplus to invest in addition to the investments required for your financial goals.
You can take a look at the following options for your debt portfolio after retirement.
Post office Monthly Income Scheme (POMIS)
POMIS is an ideal product for retired persons to ensure a monthly income. It gives around 6.6% return payable monthly. The interest earned is taxable and there’s very little liquidity.
If you’ve a requirement of Monthly Income, you can invest in the scheme without a second thought.
Senior Citizens Savings Scheme (SCSS)
SCSS offers the highest return of 7.4% in debt category, and the interest is payable quarterly. You can extend the 5-year term for another 3 years. The interest earned is taxable and the upper limit for investment is only 15 Lakhs.
Also Read: Best Investment Options For Senior Citizens
Also Read: Senior Citizen Savings Scheme
Other Debt Options For Investments
Sukanya Samriddhi Account (SSA)
Sukanya Samriddhi account is the best option if you’re a proud father of your daughter. It’s true that all the above-mentioned investments can be used for your child`s higher education and marriage goal. But an SSA account offers the best returns on investments. Considering the current interest rates of 7.6%, it’s a much better option. Especially if you want to invest in debt instruments for your daughter`s higher education and marriage goal.
Also Read – Sukanya Samriddhi Account
Note – Don’t invest in VPF for your child`s education and marriage goal as it has plenty of restrictions on withdrawals.
Without a doubt, there’re various other investment options like National Savings Scheme (NSC), Kisan Vikas Patra, Tax-free Bonds, Government securities, annuities plans etc. You can park your money in these investments as per your requirements. There’s no such thing as an ideal debt portfolio because it differs from case to case. But remember one thing, your debt portfolio’s purpose is to balance your equity portfolio, not to earn extra returns.
Do let me know if you have any queries, till then