Introduction: Allocating to Debt investments in your portfolio

As a salaried professional, it is important to have a well-diversified investment portfolio to achieve your financial goals. One of the ways to achieve this is by allocating a portion of your assets to debt investments. In this aspect, It is also important to consider the factors that affect your overall asset allocation.

In this article, we will discuss the different debt investment options available in India and how to choose the right one for you as part of your asset allocation. We will also provide an in-depth look at the various types of debt mutual funds available in India.

What are Debt Investments?

Debt investments, also known as fixed income investments, are investments where the investor loans money to an entity (such as a government, corporation, or individual) with the expectation of receiving regular interest payments and the return of the principal at maturity.

Few examples of debt investments include government bonds, corporate bonds, fixed deposits, and small savings schemes.

Why Invest in Debt?

  • Low Risk: Debt investments are less risky than equity investments (such as stocks) and the returns are usually more stable and predictable.
  • Diversification: Adding debt investments to your portfolio can help diversify your assets and reduce overall portfolio risk.
  • Portfolio re-balancing: As you near an important financial goal, transferring the invested corpus from a riskier asset like equity to a debt investment protects it from volatility ensuring your cash-flow requirements can be met.
  • Maturity: Unlike equity, debt investments like bonds have a fixed maturity term. This term can overlap your cash-flow requirements for a financial goal.

Factors to Consider when Choosing a Debt Investment

  • Risk: It is important to consider the risk associated with the debt investment. Government bonds and fixed deposits are considered to be the safest options, while corporate bonds are riskier.
  • Returns: Interest income is fully taxable except EEE investments like PPF/EPF/VPF which are tax-free.
  • Maturity: Consider the maturity of the debt investment. The higher the overlap of the maturity period with your investment horizon, the lower the reinvestment risk. Long-term Gilt funds provide higher interest rates but are subject to interest rate risk.
  • Taxation: Investors can avail indexation benefits on capital gains from debt funds after a minimum three-year holding period.
  • Liquidity: PPF/EPF are ideal investment options for the long term but do not provide liquidity. However, short-term debt funds are liquid and are suitable for parking emergency funds.

Debt Investment Options in India

  • Government Bonds: These are bonds issued by the government of India to raise money for various development projects. Government bonds are rated “SOV” i.e., sovereign which is the highest credit rating.
  • Corporate Bonds: These are bonds issued by companies to raise money for their operations. These could be rated from AAA to A- to BBB or lower. Unlike government bonds these carry a risk of default.
  • Public Provident Fund (PPF): This is a long-term savings scheme offered by the government of India currently offering 7.1% annual interest. It offers tax benefits under Section 80C of the Income Tax Act and has a term of 15 years.
  • Bank Fixed Deposits: These are fixed deposits offered by banks. DICGC insures deposits up to ₹5lakhs for each account holder in case of bank default.
  • Debt Mutual Funds: These are funds that invest in a portfolio of fixed income securities such as bonds, commercial papers, and treasury bills. They offer higher returns than fixed deposits and are less risky than equity mutual funds.
  • Employee Provident Fund (EPF): This is an ideal retirement savings scheme for salaried individuals, currently offering 8.1% annual interest, working in the private sector. Employees can choose to increase their contribution through the Voluntary Provident Fund scheme though interest on employee contributions above ₹2,50,000 in a financial year are taxable at the slab rate.

Types of Debt Mutual Funds in India

Debt mutual funds are funds that invest in a portfolio of fixed income securities such as bonds, commercial papers, and treasury bills. Here are some common types of debt mutual funds in India:

  • Gilt Funds: These funds invest in government securities. They are the safest debt mutual funds due to their SOV rating. However, they are subject to interest rate and reinvestment risk.
  • Income Funds: These funds invest in a mix of government and corporate bonds. However, as a salaried employee, these funds are not required in your accumulation phase.
  • Short-term Bond Funds: These funds invest in bonds that have a short maturity period. They less risky and less volatile than long-term bond funds but offer lower returns.
  • Corporate Bond Funds: These funds invest in corporate bonds. They offer higher returns than gilt funds and are subject to credit default risk and reinvestment risk.
  • Credit Risk Funds: These funds invest in bonds that are rated lower by credit rating agencies. Though they offer high returns, these funds should be avoided due to the high risk of default and the subsequent risk of loss of capital.

Before investing in a debt fund, it is important to go through the fund factsheet. This article explains how to analyse a debt fund factsheet.

Conclusion

As a salaried professional, you have a plethora of debt investment options available in India to choose from. It’s important to consider the risk, returns, maturity, and taxation of the debt investment before making a decision.

Additionally, you can opt for debt mutual funds with different types of options and analyze credit ratings and YTM to make wise decisions. Remember, debt investments may not give you the high returns of equity investments, but they provide a sense of security and a steady stream of income that can help you plan and achieve your financial goals with ease.

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