A safe investment sounds like a paradox, considering the jaw-dropping losses investors suffered during the global financial crisis. Be it stocks, bonds or real estate portfolios, the crisis swept across all asset classes, giving investors sleepless nights. Although experts are of the view that the worst is behind us and the scepticism seems to have waned, one still needs to be careful about where he invests. Dhirendra Kumar, CEO of Value Research, insists that there is no such thing as an 'invest and forget' approach.
Only bank deposits and small savings schemes could qualify for this tag. These are perhaps the least favoured currently owing to the reduced rate of interest on fixed deposits and the cap on investment in some small savings schemes. In fact, the rate of interest offered on deposits is unlikely to beat inflation in the future. For instance, if you fall in the 30 per cent tax bracket, an interest of 7 per cent per annum earned on a one-year deposit translates to a 4.9 per cent post-tax return, which is just under the inflation target of 5 per cent set for this year. The other disadvantage of banks is that only up to Rs 1 lakh of your deposit is insured by the government.
If you want to earn more, you could consider corporate fixed deposits, which, in the past two years, have offered better rates of interest. However, this comes with an additional risk. While small savings schemes carry the sovereign tag, you can invest only up to Rs 70,000 in the Public Provident Fund (PPF). Also, the interest earned on your investment in the National Savings Certificate (NSC) is not exempt from tax, which brings down your effective rate of return. The advantage of such investments is that they are the lowest on the risk spectrum. However, as most of us want some good returns as well, it may be prudent to opt for investment avenues that offer better riskadjusted returns and perform decently in a down market. Ultimately, it's this perfect combination that is going to allow you to get a good night's sleep.
So, is there any such investment? Kumar suggests that investors look at income funds from a longer term perspective for a fixed income portfolio. Most income funds have an exposure to AAA-rated bonds with no suspicious investment in their portfolio, he says. In the long run, these funds fetch better returns than other short-term funds. However, he adds, investors might be saddled with capital loss in case of a sharp rise in interest rates. Generally, these funds have managed interest rates with dynamism. The maturity of the underlying portfolio of income funds has ranged between one year and 15 years within the same fund, which clearly proves their claim.
One could also invest in arbitrage funds, which primarily generate income by capitalising on the mis-pricing between the cash market and derivatives market. Every purchase in the cash market is matched by a corresponding sale for the same quantity in the futures market. As arbitrage funds do not take any directional calls, these too are low on the risk spectrum and offer attractive tax-free returns of 6-7 per cent annually. The tax treatment for these funds is the same as for equity-oriented funds.
In the future, the biggest concern for investors will be to beat inflation. While investing in equities is considered riskier than in bonds, in reality, inflation could eat into the returns of a fixed income portfolio even as equities offer a hedge against inflation, says Parag Parikh, chairman, Parag Parikh Financial Advisory Services. This does not mean that you should blindly invest in stocks and equity funds at the cost of your risk tolerance. Buy stocks or funds that offer you returns commensurate with your risk appetite, but make sure there's some cushioning if the markets become negative.
Take dividend yield funds. These are known to be less volatile during a downturn because they invest in defensive sectors. They refrain from high-growth, high-PE and momentum stocks. Instead, they invest in high cash flowgenerating companies with low volatility in earnings. This offers them some cushioning when the stock markets plunge.
Source: Money Today.
Reproduced From Money Today. © 2010. LMIL. All rights reserved by them.
Reproduced From Money Today. © 2010. LMIL. All rights reserved by them.
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