2020: One big learning and some actionables

 

Life is one roller coaster of a ride and the experience of highs and lows are what add wealth to our lives. 2020 has been a remarkable year. An event which none could imagine, actually affected the whole world and yet it has been a fabulous year of learning and adapting.

 My learning in one line which elaborated below.

 Always be prepared for the worst, while being optimistic about the future.

Simple line, but when I pondered on this, it has a lot of implications and actionables.

We will look at the first part of this – Always be prepared for the worst.

Those most affected by the covid virus were small businesses and their employees who lost jobs or faced salary cuts. The General Manager of a large establishment with a huge salary, found himself agreeing to get basic minimum pay as per Govt. norms for the last few months and he was lucky. Many businessmen faced huge losses and many salaried employees were out of a job. So, what are my learnings and actionables?

1. Always, always keep personal debt to the minimum – if at all you need to take on debt:

Debt is a killer of finances and those stuck in EMIs due to buying expensive cars, phones and even that extra flat they did not need have suffered the most. If you cannot pay off that credit card fully every month, you should stick to using debit cards only. Freedom is being debt-free. A corollary of this is - I observed this year that much of fancy stuff we accumulate, we do not need.

2. Keep an emergency fund AND use it for emergencies only. This is is self evident now. A black swan event like the covid pandemic has only underscored the need to have an emergency fund and to use it for emergencies only – not for personal consumption. Not to be touched when you see a huge discount sale, neither for stock market trading. 

3. Have proper life and medical insurance to safe guard your family

4. In Investing: STICK TO ASSET ALLOCATION. It works!!! My favourite mantra!

I have always emphasised on asset allocation and believe me it was the most difficult to stick to this in 2017 when the market was simply rocketing up. The below 2 charts will show you what I mean.

This first chart depicts a 3 year lump sum return from 23.3.17 to 23.3.20 when the Nifty fell to a low. A portfolio consisting 60% of a multicap fund and 40% of a short term bond fund with yearly rebalancing did better than the Nifty 500 TRI. In fact was positive when the index was negative 

THREE YEAR RETURNS TILL 23.3.20. ASSET ALLOCATION PAYS
Balanced portfolio was positive even at the market lows!!

Chart 2 - same investment continued till 23.12.20 when the market is at a high.

BALANCED, ALLOCATED PORTFOLIO: LESS VOLATILE AND GOOD OUTCOME

This second chart is very interesting. The same 60:40 portfolio was kept up till 23.12.20. Inspite of the market touching new highs, the equity:debt portfolio has matched up so far. This may change if the market shoots up but this chart shows how the journey has been smoother. It takes discipline and strength to keep to an asset allocation framework in extreme markets.

5. My final point under being prepared for the worst is to focus on your career and develop skills so that you do not suffer professionally in case of such events like covid. Keep learning. Keep equiping yourself. Your skill sets will help you. I cannot emphasize this enough. Seeing too many who are working from home, get distracted and say - "hey lets learn to make a living off trading stocks and options". Ill advised and remember, the source of your income is not investments in the beginning. It is your profession.

Being ready for the worst would mean that you are never shocked by any event and can bounce back quickly.

Now to the second part of the learning – Be optimistic, be positive.

 Human ingenuity has overcome terrible problems in the past and hey, there is no reason we will not overcome tough situations in the future. Being optimistic helps when you are investing in market related instruments. The market is certainly no place for pessimists, negative folk. A positive mind set made many investors see opportunities and I personally know many who kept investing from April and have made tremendous gains.  Many others continued their SIPs which work best in volatility. Below are two charts of  SIPs. One 5 years SIP ending on 23.3.20 in the NIFTY 500 TRI gave a NEGATIVE -8.7%. The same SIP if continued till December gave a POSITIVE 12.4% annualised!!! Unbelieavable no?. This is the CAGR!! Just 9 months made a HUGE difference. Look at the 2 charts below.

 

IF YOU STOPPED A 5 YEAR SIP IN MARCH- YOU ENDED UP NEGATIVE - 8.7%

If you had continued the SIP till December, the -8.7% annualised return has become +12.4%

THE SAME SIP CONTINUED HAS GIVEN ANNUALISED 12.4%. THE VERY SAME SIP!!!

Some corollaries from BE OPTIMISTIC: 

Do not panic when things are bad. Those who panicked and redeemed in the months after covid struck have lost big!!! Do not stop SIPs and withdraw. Stay the course when you have a plan.

Do not procrastinate. I deal with many investors and a few have been dilly-dallying and procrastinating. A delay can cost big. Guys who spoke to me from June on are still deciding in December!!! The markets have seen a dizzying rise. And those who allocated when the markets were down, certainly have a good start which gives a lot of confidence in one's investment journey.

In brief 

1. Debt is a killer. Live within your means

2. Keep an emegency fund and be prepared for the worst.

3. Have adequate medical and life insurance to protect loved ones.

4. Stick to asset allocation!! Have a process! 

5. Focus on your career and business and build skillsets. That alone will provide you the money required to grow wealth. DO NOT get distracted by your neighbour trading in options.

Being ready for the worst would mean that you are never stunned into inaction or impusive actions when events like covid happen. Being ready means you adapt with clarity of thought.

6. Be positive. A positive and optimistic attitude alone will let you see opportunities even when the going is tough.

Wishing you all a Happy New Year, filled with health and peace of mind....And Happy Investing

I am a mutual fund distributor and you can follow me on twitter here. 

Mutual Fund investments are subject to market risks. Read all scheme related documents carefully before investing.

Create your Serendipity as an investor

Many of us downplay the role of “luck”, “chance”, “karma” in our careers, our investing, our personal lives.

Where there is choice, there can be conflict created by the choices. To invest now when the Nifty is at all time highs or not to invest, to marry this person or not to marry…to quit this great job and go for my own start up or not to….And there is a choice in everything.

Now, while we all have a free will and an intellect to discriminate and take calculated risks and go ahead with a decision, there are hundreds of factors our intellects cannot see or consider in any deliberation. Yet we go ahead with a course of action. What differentiates a calculated risk from a wild risk is this deliberation. Yet, there is risk, always, of not getting a desired outcome.

Often, we see that our planned course of action, our investment succeeds and sometimes there is wild success, despite hundreds of things we could not see while deliberating. Wise folk recognize the role played by “luck”/“chance”/ “karma”.

I recently heard a very interesting conversation between two brilliant and successful men – Mr. V Shankar, Founder CAMS and Mr. G V Ravishankar, Managing Director at Sequoia Capital, in which Mr. VS asked Mr. GVR to speak about something the latter had written in the context of venture capital investing – “Create your Serendipity”. (Serendipity is translated as Chance, Fate, Destiny, Luck). In short – how to create conditions favourable for you to get lucky!!!

The response from a very successful man struck me and was insightful and in short was as below:

Depending solely on chance for success to come in your choices is like trying to win a lottery. One can create the conditions for Lady Luck to visit and one can “manage serendipity”. This is said in the context of his VC business.

1. Be there, always. Be committed, have passion and be there to take decisions.
2. Make yourself heard – to let potential entrepreneurs know that you are there to evaluate a venture of theirs. Let folk know what you do and that you are there.
3. Give time! You cannot be impatient. Give time for the seed to become a tree.

When all the three are there, the chances of success are higher.

Now, let’s look at this in the context of investing – to get financial freedom.

All investing is forecasting. We want a particular outcome but there are hundreds of factors we cannot see. 2020 is a great example of things turning upside down and life being disrupted in a way we did not think possible. So, how does one create conditions favourable for success in reaching financial goals and getting success in investing.

My take:

1    Be committed. 

     Be committed to a savings plan, to sticking to your process and staying the course. I have seen that those who impulsively deviate from their planned investing process, allocation invariably get a sub optimal result. Have seen actual instances of folk impulsively sell off in March at the lowest of low points and disturb their equity allocation, instead of following process. Just sticking on would have meant being in gains now. One did not know how the future would unfold but deviations from asset allocation hurt. Those who stuck to their SIPs, were there (Be there- be committed) have gained. Those who stuck to allocation and moved funds into equity did even better and created their serendipity. One may say that this is said in hindsight, but do check out previous instances in your own investing lives and note them down.

2.       Be open: Be open-minded to:

• Check out all products and not derisively dismiss anything. I find folk on twitter dismissing various products just because they are from AMCs. You alone lose if you do not know about a product and way it can help you. I have been served through out life by making an attempt to get insights about how various investment instruments work.

• Seek advice if you think you will be better served along your journey with advice. Obstinate refusal to take help will keep you away from learning much and gaining much.

3.       Give time: Be patient:

Results take time to fructify. Patience is required to sit out volatility. Patience is required to allow time for the investment to give results. Patience would mean you are invested in that one good year which will make a big difference to your investment outcome.

 I'm never tired of looking at this graph of the Nifty in 2020. Serendipity through patience, in a graph :)

NIFTY 50 YEAR TO DATE

So, if you are committed, you are open-minded and patient, you will often be creating your serendipity. Do save this, try it and in time let me know how Lady Luck has blessed you. Follow me on twitter.

DISCLAIMERS:

I am an AMFI-Registered Mutual Fund Distributor.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME RELATED DOCUMENTS CAREFULLY BEFORE INVESTING

Investing though a bumpy ride: Having a stable support

 

Investing though a bumpy ride: Having a stable support

My article with similar thoughts was published today in the Morningstar

During my school days, two of my friends and I would go often on public buses to explore the city. Those who have travelled in Chennai’s public buses during traffic hours know about the bumps, sharp turns, sudden brakes which would shove us front, throw us back, and get us swaying. To avoid getting hurt, I would always hold on to the holders or to the front seat when seated. One friend would sit confidently and use little support only when required - when the bus was braking and making sharp turns. He was not affected much by sharp movements and seemed to enjoy turbulent rides. The third guy wouldn’t want to take any chances and would always use both hands and tightly hold on to the holders or seat in front if he were seated. He was clear – bus drivers are not to be trusted and he wanted a firm support, just in case.

Three different folk – affected differently, responding differently.

As I think about it, our investing journeys, just like bus journeys are a bumpy ride, what with huge volatility and in addition, uncertainty of reaching our destination (financial goals). And each of us taking the journey has a different temperament – like the three of us travellers in the bus.

Some of us can take all the volatility and not bother – because we may have the capacity to take such risk, having a mental makeup that zooms out and sees things objectively OR having secure jobs, financial stability already etc. The volatility in the markets may shake some of us – but not so much that we are shattered and get badly hurt. For the rest – may I say the majority, going through a huge drawdown can be a shattering experience mentally. Even financially, a majority of the investors are not prepared to recover from a 50% drawdown in equities.

You’ve guessed it right: The point I am coming to is what I keep making on twitter - the importance asset allocation. Refer to the bus example. We used a support, an anchor to keep us in place and safe when there were sharp movements. So also, investors, in their investing journey need a stable anchor to hold on to.

This is why I often speak about the need for Liquidity and Stability in the form of Liquid Funds, FDs, Bond Funds as the stable anchors to see us through volatile times. Add gold to this also. When markets are volatile and there has been a drawdown - at that time to make a rush to safety and liquidity would be terrible. You would be selling a loss. What if you already had an allocation to your stability anchors. You would then have a relatively calm mind and be able to think objectively.

Wanting to keep this message short – I will end by saying – Know your mental make up and your financial capacity – BOTH. Then, accordingly decide your need for stable anchors in your investment basket. In the financial journey there is more uncertainty than in a bus journey, so the need to be more careful.

Mutual Fund investments are subject to market risk. Read all scheme related documents carefully before investing

(I am a mutual fund distributor. Connect with me on twitter)

 

RETAIN YOUR OBJECTIVITY - IN LIFE AND INVESTING

As a young school kid in primary school I would look towards the high school section, see bigger guys, and wait to grow up and “be like them”. As an executive in a company you want to grow to be a manager. As a manager, one wants to get into higher management. A businessman wants to increase turnover and profits.  All these are different examples for only ONE thing – the universal human need to grow, expand and feel full and complete.

Wanting to grow, expand and feel full is human nature.

Now come to the world of personal finance and investing. Fitwit has many people people speaking only about themselves, their investments and their success and it is but natural for beginners, newbies and many investors to “be like them” – to grow, get rich, feel complete and successful. For every investor, the means to expand, grow, feel full is to follow a path that takes them to such success. This strong desire to FEEL FULL and NOT FEEL SMALL - is the root of action of every individual.

I am discussing investors and their behaviour. While wanting to be full and complete is natural, what harms is the strong desire to do it fast. This leads to the dulling of discriminative ability.

Think about it – all greed, instinctive decisions, stupid allocation is the result of this wanting to grow fast, quickly. And… the worst thing to happen is to do it by:

• Reading clickbait headlines
• Taking tips, free advice from various media
• Listening to fake folklore of office colleagues, cousins
• Blindly following authoritative figures.

 As an objective individual, it is easy to call out nonsense, but…. this need to grow fast and feel full takes over and we simply lose all objectivity.

 A true story.

 Three years ago, an entrepreneur running an SME came to me to onboard and I discussed with him a scheme of allocation, keeping the overheated market in mind. He pooh poohed the allocation showing data of recent returns of small caps and of individuals on twitter. Disagreeing with his utter disregard of advice and with his misallocation, I did not onboard him and he put directly a large sum in 100% equity, heavily tilted toward mid and small cap funds. We all know what happened since 2017. Greed, fuelled by a desire to be successful, to get rich soon, led him to lose objectivity and to ignore warnings of mis allocation. The story continues…the same investor redeemed everything at a low in March 2020, losing very heavily and has come back for help on asset allocation.

 While one can feel sorry for such misfortune, the one take away we can have from all this – We all want to grow. But growth requires time and the ability to filter out the bulls**t from the truth and choose rightly. In Sanskrit the word Viveka is used for ability to discriminate – crap from reality. Viveka also means you know when you can use help, advice rather than getting it free from gyan. Use this discriminative power and it will help you as an investor and through out life.

 

MUTUAL FUNDS ARE SUBJECT TO MARKET RISK. READ ALL SCHEME RELATED DOCUMENTS CAREFULLY BEFORE INVESTING.

DISCLAIMER: I AM A MUTUAL FUND DISTIRBUTOR

 

 

 

 

 

 

  

Readymade asset allocation products - should investors use these?

The purpose of this post:

• Is NOT to compare between different types of funds.
• Is only to reinforce my point that asset allocation must be continued even if our moods change from extremely negative to very positive. It is my experience that you will get a better result sticking to an asset allocation
• Is to make a point that products offered by mutual funds should not be written off just because some on social media criticize. Study for yourself and drop or accept a product.

That said...

"The most important key to successful investing can be summed up in just two words-asset allocation." ~ Michael LeBoeuf. I’ve been tweeting on this often. I often receive DMs and messages on various funds which offer asset allocation and whether they will be useful for retail investors. More often queries come because investors affected by criticism of everything on twitter and unfortunately retail investors get carried with this and make stupid decisions. Having received too many queries, I give here, a small note and start by saying – Do not reject anything unless you have analysed it yourself or tried and found it not suitable. What is useless for others may be good for you!!!

A small note on 2 of the common asset allocation products offered by mutual funds: I answer actual queries received.

AGGRESIVE HYBRID FUNDS:

These funds are designed in such a way that you have > 65% in equity to get the status of an equity fund. More often than not we find that the equity:debt ratio is closer to 75:25. So for an aggressive equity:debt allocation – a static non changing allocation, these are available.

So, why invest in these?

If you want a static asset allocation of about 70:30 in equity:debt. The debt part will protect against very heavy drawdowns. This ensures automatic tax efficient rebalancing. That is, when equity markets rise, equity will be sold off and when equity markets fall, debt will reduced and equity part increased to maintain the asset allocation. In a bull market a 100% equity allocation will far outperform and we as investors get carried away and do not protect our portfolios. A March 2020 like drawdown teaches us great lessons.

Any precautions I should take?

YES!! Two very important points to note. First, I would go for a fund that predominantly invests in large caps. Adventurism into small and mid caps has hurt some funds. Second, be aware of the debt part of the portfolio – it should have familiar sounding high quality paper. Many avaiable funds do follow the above guidelines.

So, did these really protect in the recent steep fall in equity prices??

Good question. Many of these funds which follow the above rules did protect. At one time benchmark indices were down >30% from highs. Below is a graph of 3 funds compared to a Nifty 50 Fund. The point is NOT to compare performance, but a simple visual representation to show that having asset allocation will protect you when there are big drawdowns and your portfolio will end up doing better if you maintain discipline in asset allocation. March 2020 was an eye opener.

 

So, why so much criticism on social media?

The one really jarring note about these is that when markets boomed after demonetisation, these were missold as alternatives to FDs and bought for monthly or quarterly dividends. That IS NOT the reason to invest in these. Another issue is that some fund houses may not have the highest quality debt in their hybrid funds. Recently fund houses which transferred papers from their credit risk funds to their hybrid funds caused great concern and received criticism. Be aware of shenanigans.

Your final take?

As long as you consider the above points- look for a stable large cap based portfolio and quality debt, I believe these have a place in investor portfolios. Note, in a raging bull market, a portfolio of 100% equity will far out perform. But, markets move in cycles. And it is my conviction that asset allocation ensures a better outcome for your portfolio! How you do it is your call.

Final point – know why you are investing in these – NOT for a monthly dividend, but for maintaining a static, aggresive asset allocation. Remember, stick to funds investing in larger caps.

The other popular hybrid product fund houses offer:

Dynamic Equity funds:

Unlike the above Aggressive Hybrid Equity Funds, these as the name goes – dynamically shift the equity and debt portions. The equity position can fluctuate between 20% to 80% depending on the model used by the fund. These are also popularly known as Balanced Advantage Funds! These are much more conservative than the aggressive hybrid equity funds.

So how do these work?

I can write a full post on these, but in brief, based on either a valuation model or a trend following model, the equity part of the portfolio will dynamically change according to the market conditions. So, in the last few years, I have seen the equity part of some such schemes go from 20% to 65% or maybe more.

Any example of how equity levels changed in a fund?

Yes, I just saw some data put up by a fund house on how the equity allocation has changed dynamically at various NIFTY levels and the table is shared below

 

An interesting comment I received:

Some on social media emphasize that we should do our own allocation and talk down these. What should I do?

Answer: They have their own systems and ideas and even though brilliant, their methods may or may not be suitable to you. Try out your own model. AMCs offer a readymade dynamic model and have been true to their models in most cases. It is up to you to see if they work for you. If you are a conservative investor there may be a place for a type of product which can do unemotional investing – buying low when things are bad while selling high when things are good. And do this in disciplined manner over and over again. Or we have the other type of Dynamic Fund which consistently aims to maintain higher equity levels when markets are going up and vice versa. Try for yourself.

The below graph shows how they contained the drawdown in March.

 

By and large, these funds have served a conservative investor well. It is important to note that the return expectation from these funds should be tempered. With so much debt and arbitrage positions, they are by nature defensive. These are not alternatives to FDs and these too have been missold for monthly/quarterly dividends.

Caution!

When investing in these you have to ensure that the fund house follows it model. One large fund house has such a scheme and disregards dynamic rules and uses it as an aggressive fund. That has not protected investors.

 

There are other types of hybrid funds becoming popular – multi asset funds which have gained popularity after the run up in gold. More about these at some other time.

In conclusion, this fall in stock prices has showed us how essential it is to have an asset allocation. Not all will use readymade asset allocation models like the hybrid funds AMCs offer. However, you decide for yourself. What is important is that you look more deeply at asset allocation and use your own model or a readymade investment product.

 

 

4 expensive misadventures in investing

Markets have seen steep falls since the Covid 19 lockdown.

I shared my thoughts with Larissa Fernand on errors and misadventures that can destroy portfolios, based on queries I've been receiving from investors since March. These were published in The Morningstar 

4 expensive misadventures in investing 

Based on interactions with clients, friends and acquaintances, MAHESH MIRPURI recently tweeted about what is going on in the minds of investors. 

Being a financial coach and adviser, he neatly put it across as misadventures in investing. Here he fleshes out the points to caution investors on how to be wise in such uncertain times. 

Here is something that you must know: You can gain substantially in your portfolio by avoiding mistakes. Win, by not losing. Skip these misadventures, and you are automatically ahead in the game. In fact, it is more crucial to avoid certain errors, than hunt for the “best” instrument.

The misadventure: Ignoring risk when chasing a higher yield. 

The Reserve Bank of India recently lowered its repo rate to 4%, and the reverse repo rate to 3.35%. 

The repo rate is the rate at which the RBI lends to other banks. The reverse repo rate is the rate at which the RBI borrows from banks.These are the benchmark rates in the economy, which means that these as such, form a basis for all other interest rates. 

Worth noting is that these are the lowest rates we have had since 2000. With India facing an economic downturn, the rates may not rise soon. Banks have consequently dropped lending and fixed deposit rates and this has made senior citizens anxious. 

To compensate, investors are now looking at instruments that offer a higher return, choosing to ignore the risk of losing capital. Senior citizens have enquired about Company FDs, NCDs and other instruments which carry a risk of losing capital. 

Please consider safety of capital more especially, at this critical time like this. Senior citizens can consider the Senior Citizens Savings Scheme @7.4% or RBI Taxable Bonds @ 7.75% or the Pradhan Mantri Vaya Vandana Yojana – a pension scheme.  A host of other small savings schemes are also available.

 The misadventure: Playing the guessing game. 

I keep getting calls or requests for advice on whether a stock is a good buy at a particular price. "Stock ABC was Rs 500. Today, it is quoting at Rs 350. Should I buy?” 

I answer such queries by posing another question: What is your anchor? 

Let me explain. We don’t realize how dominant the anchoring bias is. This is when our brain unconsciously seeks a reference or starting point when guessing an answer. 

Let’s say I began to track a stock when it was Rs 3,000. Now that it has dropped to Rs 2,000, I believe it is cheap. But is it? To really figure out if it is cheap, you must study the stock in detail. Maybe it is still expensive at Rs 2,000. Maybe it was cheap at Rs 3,000 and is cheaper still. And if that is the case, why is it falling so rapidly? Is there a reason it is plunging faster than other players in the same sector? 

Don’t rush to buy because your mind is anchored to a previous price. Study. Analyse. Don’t guess.

 The misadventure: Betting recklessly. 

After Demonetisation, it was a dream run for the Indian stock market.  

The Sensex stood at 27,591 on November 8, 2016. As millions of investors channelized their money into equity funds since interest rates dropped substantially, there was a phenomenal rally – and spectacular gains in small and mid caps. Seeing recent performance, thousands of investors poured money into small and mid cap funds and stocks, fuelling a stellar run. And while there were substantial corrections along the way, the Sensex touched an all-time high of 41,000 before this steep fall. 

The problem is that many investors flocked to the asset class with no clue as to how volatile it can be and how punishing a steep fall can be. 

To add fuel to the fire, many investors have invested a substantial part of their financial assets into equity alone. Zero respect was paid to asset allocation. Such portfolios have suffered tremendous damage.  

Never bet recklessly on one single asset. Always ensure proper asset allocation and diversification.

 The misadventure: Chasing returns.

 This has always been an investor weakness. Invest in the sector once it rallies. Invest in a fund once it tops the chart.  

A number of investors now want to bet on gilt funds. Why? Because they have put up some excellent return figures. No one considered them when yields were high. Today, when 10-year paper is at 5.96%, maximum enquiries come in for gilt funds. Why? Because investors are looking at the recent past performance, without enquiring into why!  

Agreed, gilt funds have no credit risk. There is no risk of default. But they do have interest rate risk. 

In simple language, if interest rates rise, the price of the bonds will fall. If interest rates fall, the price of the bonds will rise. Interest rates (yields on bonds) have fallen tremendously and this means bond funds have given very good gains. Now instead of chasing such funds, ponder, how far lower can interest rates go? 

If you wish to invest in gilt funds, understand the offering and consider it as a tactical play. I have written about it in How to build a debt portfolio. 

Investing simply based on recent performance can turn out to be a misadventure. 

In conclusion, to avoid the mistakes enumerated above, develop a deliberate and thoughtful investment process and stick by it. You will be well on your way to having a good investment portfolio. 

Approach to creating a debt portfolio

                                                                                                                                                           

BOND FUNDS

I wrote an article in the Morningstar and am reproducing the same here.  

Approach to creating a debt portfolio

The first step to creating any portfolio, is to decide on the equity and debt combination. The allocation to equity will rest on three factors: when you need the money, an honest appraisal of your capability for risk, and the volatility you can stomach.

When it comes to debt, there are two aspects you must never lose sight of: Safety and Liquidity.I say this because the prime aim of a debt fund is capital preservation and stability to the overall portfolio. It is supposed to make it easier to stomach risk elsewhere in the portfolio. Investors can inadvertently sabotage their portfolios by trying to juice returns by adding risky debt.

It is very easy to get carried away by advice doled out of Twitter or television. Random transaction-based investing will harm you and you will end up with a lot of "junk". Never view any investment in isolation, always view it in relation to your portfolio. Once you adopt this step, then you will get investments that complement each other, at the same time, avoiding portfolio clutter and duplication.

There are three elements to consider when constructing a debt portfolio.

1.    An Emergency Fund

An emergency, by its intrinsic nature, is meant for unexpected and emergency events. Which means, you will need to use them instantly. Don’t chase returns here, keep a laser-like focus only on Liquidity and Safety. This is all that matters. I suggest  bank fixed deposits. If you want to consider mutual funds, go for liquid and ultra short-term funds. Alternatively, you can consider dividing the emergency fund amongst these options.

Liquid funds primarily invest in money market instruments like commercial paper (CP), treasury bill (T-bills) and certificate of deposit (CD) with low maturity period.

Ultra short-term funds primarily invest in liquid fixed income securities which have short-term maturities.

2.    Core Portfolio

This bucket contains the bulk of fixed income allocations and provides for a nest-egg to the overall asset allocation of an investor. The chief pursuit here is one of safety.

I suggest you layer it.

Look at assured return investments such as fixed deposits, Employee Provident Fund (EPF), Public Provident Fund (PPF), RBI bonds, and small savings schemes.

Build on this base with debt mutual funds that are low on both, duration and credit risk. Do not deviate from this rule and you will avoid credit risk and interest rate risk. The advantage of this type of debt mutual funds is that investors get the benefit of lower tax rates (if held for > 3 years) and market returns. The appreciation in these funds is not only from the accrual of interest income, but possible capital appreciation due to interest rate movements.

 

3.    Tactical Portfolio

This is where you can afford to be experimental and look for higher returns. To take advantage of market conditions, 15-20% of your debt allocation can be funnelled into this bucket.

Gilt funds would fit here. These funds have no credit risk or risk of default. Their risk is interest rate movements. If you expect interest rates to dip in the future, you could consider a tactical bet here.

Dynamic bond funds would fall under this category. Consider them after getting well acquainted with the fund manager’s strategy. Steer clear of funds with credit risk. 

Credit risk funds too fall in this satellite category. These funds do not even come onto my radar as I see no point in taking on risk of default and wiping out capital permanently.

Non-convertible debentures (NCD) issued by companies also fall into this category. But the risk here cannot be ignored.

A word of caution to retail investors when it comes to debt funds.

·         Start with the question: why do I need market-linked debt instruments? Once that is answered, take it forward using safety and liquidity as the two guiding posts.

·         Understand the nuances of each fund. Different types of debt funds carry different risks. The risk of a credit fund is totally different from that of a gilt fund. Gilt funds, on the other hand, are not a homogenous lot. The category has actively managed gilt funds and constant maturity gilt funds. Understand what the fund invests in and its risks.

·         When evaluating a fund, keep various factors in mind; whether it is purely open ended or a “target maturity” fund, weighted average maturity, credit quality and expense ratio.  Liquidity of the portfolio must also be considered. Your open-ended debt fund must be able to provide for liquidity in the assets that it holds. This means that when faced with redemptions it should have assets that can be liquidated and with reasonable impact costs. When selling assets, the risk profile of the remaining assets should not shoot up or be concentrated, like we have seen in the recent credit fund crisis

·         Finally, don’t invest ONLY because the past performance has been great. This is a mistake many a retail investor is susceptible to.

 If all of this seems a bit overwhelming, I suggest that you take the help of a knowledgeable guide or a financial adviser OR you can approach me.

MUTUAL FUNDS ARE SUBJECT TO MARKET RISK. PLEASE READ ALL SCHEME DOCUMENTS CAREFULLY BEFORE INVESTING